A firm has issued $20 million in long-term bonds that now have 10 years remainin

Question

A firm has issued $20 million in long-term bonds that now have 10 years remaining until maturity. The bonds carry an 8% annual coupon but are selling in the market for $877.10. The firm also has $45 million in market value of common stock. For cost of capital purposes, what portion of the firm is debt financed and what is the after-tax cost of debt, if the tax rate is 35%? If the risk-free rate is 3%, the firm’s beta is 1.3, and market premium is 10%, what is the firm’s WACC? please post step by step.

Explanation / Answer

First calculate Cost of bond after tax:

Using financial calculator BA II Plus - Input details:

#

FV = Future Value =

$1,000

PV = Present Value =

-$877.1

N = Total number of remaining payment periods =

10

PMT = Payment =

$80

CPT > I/Y = Rate =

                  10.00

Convert Yield in annual and percentage form = Yield / 100 =

10.00%

Before tax cost of the bond = Cost of Debt financing =

10.00%

Cost of debt = YTM x (1-Tax) = 10% x (1-35%) =

6.50%

Now, calculate cost of equity:

Cost of equity = Risk free rate + Beta x Market risk premium

Cost of equity = 3% + 1.3 x 10%

Cost of equity = 16.00%

Weight of debt and weight of equity:

Debt value = Market value of debt x Total debt / Face Value of debt

Debt value = 877.1 x 20000000/1000

Debt value = 17,542,000

---

Equity value = $45,000,000

Hence,

Debt weight = 17542000 / (45000000+17542000) = 28.048352%

Equity weight = 45000000 / (45000000+17542000) = 71.951648%

Now we can calculate the WACC:

WACC = Equity cost x equity weight + Debt cost after tax x Debt weight

WACC = 16% x 71.951648% + 6.5% x 28.048352%

WACC = 13.335407%

?Please comment if any explanation need here.

Using financial calculator BA II Plus - Input details:

#

FV = Future Value =

$1,000

PV = Present Value =

-$877.1

N = Total number of remaining payment periods =

10

PMT = Payment =

$80

CPT > I/Y = Rate =

                  10.00

Convert Yield in annual and percentage form = Yield / 100 =

10.00%

Before tax cost of the bond = Cost of Debt financing =

10.00%

Cost of debt = YTM x (1-Tax) = 10% x (1-35%) =

6.50%

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.