Question

Crab Cakes Ltd. has 5million shares of stock outstanding at $15 per share and an issue of $10million in 10 percent, annual coupon bonds with a maturity of 25 years, selling at 97 percent of par ($1000).

If Crab Cakes weighted average tax rate is 30 percent, its next dividend is expected to be $1.00 per share, and future dividends are expected to grow at 5 percent per year, indefinitely.

What is its WACC?a) 8.42%b) 10.84c) 11.16d) 11.52%

Answer 1

Answer:

None of the choices is correct , please find step by step explanation to get the WACC below.

Explanation:

First, find the pretax cost of debt. Using a financial calculator, input the following;

Maturity of the bond; N = 25

Price of the bond; PV = -(0.97 *1000) = -970

Annual coupon payment; PMT = 0.10*1000 = 100

Face value of the bond ; FV = 1000

then CPT I/Y = 10.339% (this is the pretax cost of debt rD)

Next, find the cost of equity; rE = (D1/Price) +g

rE = (1/15) + 0.05

rE = 0.0667 + 0.05

rE = 0.1167 or 11.67%

Market value of equity=  5,000,000 *$15 = $75,000,000

Market value of debt = 0.97 *$10,000,000 = $9,700,000

Total market value = 75,000,000 +9,700,000 = $84,700,000

WACC = wE*rE + wD*rD(1-tax)

wE; weight of equity = 75,000,000/84,700,000 = 0.8855

wD; weight of debt = 9,700,000 / 84,700,000 = 0.1145

WACC = (0.8855*  0.1167) + [ 0.1034(1-0.30)]

WACC = 0.1033 + 0.0724

WACC = 0.1757 or 17.57%