Question

A company is currently in this situation: (1) tax rate, T = 40% ; (2) value of debt, D = $3m; (3) rd = 12% ; (4) rs = 20% ; (5) shares of stock outstanding, n = 500,000; and (6) stock price, P = $25. The firm’s market is stable and it expects no growth, so all earnings are paid out as dividends. The debt consists of bonds. Compute the WACC.

Answer 1

Answer:

WACC = rs(S/V) + rd(D/V)(1-T)

WACC = 20($12,500,000/$15,500,000) + 12($3,000,000/$15,500,000)(1-0.4)

WACC = 16.13 + 2.32

WACC = 18.45%

Market value of the company:                                        $

Market value of common stocks (500,000 x $25) 12,500,000

Market value of debt                                                 3,000,000

Market value of the company                                   15,500,000

Explanation:

In this case, there is need to compute the market value of the company, which is the aggregate of market value of equity and market value of debt.

WACC is the cost of equity multiplied by proportion of equity to the market value of the company plus after-tax cost of debt multiplied by proportion of debt to the market value of the company.