14. ABC Trucking\'s balance sheet shows a total of noncallable $36 million long-
ID: 2619954 • Letter: 1
Question
14. ABC Trucking's balance sheet shows a total of noncallable $36 million long-term debt with a coupon rate of 6.80% and a yield to maturity of 8.60%. This debt currently has a market value of $53 million. The balance sheet also shows that the company has 12 million shares of common stock, and the book value of the common equity is $230.00 million. The current stock price is $21.25 per share; stockholders' required return, rs, is 17.10%; and the firm's tax rate is 30.00%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between the WACCs using market value and the book value?
Explanation / Answer
After tax cost of debt = 0.086 ( 1 - tax)
After tax cost of debt = 0.086 ( 1 - 0.3)
After tax cost of debt = 0.0602 or 6.02%
WACC using book value:
Book value of bonds = 36,000,000
Book value of common stock = 230,000,000
Total book value of capital structure = 36,000,000 + 230,000,000 = 266,000,000
Weight of bonds = 36,000,000 / 266,000,000 = 0.135338
Weight of common stock = 230,000,000 / 266,000,000 = 0.864662
WACC = Weight of debt * cost of debt + weight of common stock * cost of common stock
WACC = 0.135338 * 0.0602 + 0.864662 * 0.171
WACC = 0.008147 + 0.14857
WACC using book value = 0.156 or 15.6%
WACC using market value:
Market value of bonds = 53,000,000
Market value of common stock = 12,000,000 * 21.25 = 255,000,000
Total book value of capital structure = 53,000,000 + 255,000,000 = 308,000,000
Weight of bonds = 53,000,000 / 308,000,000 = 0.172078
Weight of common stock = 255,000,000 / 308,000,000 = 0.827922
WACC = Weight of debt * cost of debt + weight of common stock * cost of common stock
WACC = 0.172078 * 0.0602 + 0.827922 * 0.171
WACC = 0.010359 + 0.141575
WACC using market value = 0.152 or 15.2%
Difference in WACCs = 0.156 - 0.152 = 0.004 or 0.4%
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