Question

Paraguay Pipes Inc. has a cost of equity of 11.1 percent, the YTM on the company's bonds is 5.7 percent, and the tax rate is 35 percent. The company's bonds sell for 93.1 percent of par. The debt has a book value of $393,000 and total assets have a book value of $947,000. If the market-to-book ratio is 2.59 times, what is the company's WACC?

Answer 1

Answer: 9.5978%

Step-by-step explanation:

Firstly, we should note that the total book value of equity will be the difference between the total assets book value and the total debt book value which will be:

= $947,000 - $393,000

= $554,000

Then, we'll calculate the market value which will be:

= market-to-book ratio × book value

= 2.59 × $554,000

= $1,434,860

Then, the after tax cost of debt will be:

= 5.7(1 - Tax rate)

= 5.7(1 - 35%)

= 5.7(1 - 0.35)

= 5.7(0.65)

= 3.705%

Equity = $1,434,860

Debt = $393,000 × 93.1%

= $365883

Total market value = $1,800,743

WACC = Respective costs × Respective weights

= ($1,434,860/$1,800,743 × 11.1%) + ($365883/$1,800,743 × 3.705%)

= 0.08845 + 0.007528

= 0.095978

= 9.5978%