QUESTION 7 Given the following information for Food Distributions, find its WACC

Question

QUESTION 7

Given the following information for Food Distributions, find its WACC. Assume the company s tax rate is 25 percent. Debt: 20,000, 7.0 percent coupon bonds outstanding, $1,000 par value, 15 years to maturity, selling for 98 percent of par; the bonds make semiannual coupon payments. Common stock: 200,000 shares outstanding, selling for $50 per share; the beta is 1.60. Market: 7 percent market risk premium and 4.5 percent risk-free rate.

7.29%

7.74%

8.25%

8.89%

9.43%

7.29%

7.74%

8.25%

8.89%

9.43%

Explanation / Answer

8.89%

Working:

There is a difference in answer in 2nd place of decimal due to roundig off.

Working: a. Calculate cost of debt Par Value              1,000 Semi annual coupon =              1,000 x 3.50% =                     35.00 Price of Debt =              1,000 x 98% =                        980 Semi annnual period = 15 x 2 = 30 Semi annual yield = Average income/Average Investment = (35+(1000-980)/30)/((1000+980)/2) = 3.60% Annual Yield = 3.60% x 2 = 7.21% After Tax cost of debt = 7.21%*(1-0.25) = 5.40% b. Cost of Equity = Risk free rate + Beta *Market risk premium = 4.50% +           1.60 x 7% = 15.70% c. Value of debt = 20000 x            980 =         1,96,00,000 Value of Equity = 200000 x 50 =         1,00,00,000 Total         2,96,00,000 d. Weight of : Debt 1,96,00,000 / 2,96,00,000 =           0.66 Equity 1,00,00,000 / 2,96,00,000 =           0.34           1.00 e. WACC = (Weight of debt * After tax cost of debt)+(Weight of Equity*Cost of Equity) = (0.66*5.40%)+(0.34*15.70%) = 8.90%

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