Question

Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4% and the market risk premium is 8%. Jack's tax rate is 35%. What is Jack's weighted average cost of capital

Answer 1

The answer is =10.36%

Step-by-step explanation:

The weighted average cost of capital (WACC) is a way that a company calculates its cost of financing and acquiring assets by comparing the debt and equity structure of the business.

WACC = WeRe + WdRd

We is weight of equity

Re is cost of equity

Wd is weight of debt

Rd is cost of debt

For its cost of equity:

Ke = Rf + beta(market risk premium)

Where Ke is cost of equity

Rf is risk free rate of return( treasury bill return)

4% + 1.1 x 8%

= 12.8%

Total debt 80,000 x $1,000 = $80million

Common: 4million x $40 = $160million

Total = $80milllion + $160million

=$240million.

Therefore, WACC is

WdRd= 80/240 x [8.5% x(1-35%)]

80/240 x 5.5%

=1.83%

WeRe = 160/240 x 12.8%

= 8.53%

=1.83% + 8.53%

=10.36%