Question

If Qual Corp. currently trades at $20/ per share, with 5 million shares outstanding. Their total debt is 50 million with 10- year maturity, annual bond pricing at $780 now. The coupon rate is 7%. This company has a Beta of 1.5, risk free rate is 3% and SP 500 index return is 10% now. With a tax rate 40%, please calculate the WACC.

Answer 1

Answer:

WACC = 0.10890 or 10.890%

Explanation:

The WACC or weighted average cost of capital is the cost of a firm's capital structure which contain either one or more of the following namely debt, preferred stock and common equity.

For a firm containing only two components namely debt and common equity, the formula for WACC is,

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

Where,

• w represents the weight of each component

• r represents the cost of each component

First we will calculate the weights of each component and the cost of equity.

Total value of common equity = 20 * 5 million = $100 million

Total value of debt = $50 * 780/1000 = $39 million

Total value of capital structure = 100 + 39 = 139 million

wD = 39 / 139

wE = 100 / 139

Using CAPM we calculate the cost of equity to be,

rE = 0.03 + 1.5 * (0.1 - 0.03) = 0.135 or 13.5%

WACC = 39/139 * 0.07 * (1 - 0.4)  +  100/139 * 0.135

WACC = 0.10890 or 10.890%