Ray Stokes is raising capital for a new company called NO Balloons Inc. NO Ballo

Question

Ray Stokes is raising capital for a new company called NO Balloons Inc. NO Balloons will manufacture and sell festive balloons. Because of the shortage of helium, the balloons will be filled with nitrous oxide instead. NO Balloons plans to finance the business with common equity and long-term debt. It plans to sell 12 million shares of common stock and 200,000 bonds. Each bond will have a coupon rate of 5% and will have a face value of $1,000.The common stock will be issued at a price of $19.5 a share. The bonds will sell for 89% of face value. The after-tax cost of debt is 4% and the cost of equity of 9.275%. What is NO Balloons' WACC?

A) 5%

B) 6%

C) 7%

D) 8%

E) 9%

Explanation / Answer

Value of equity = 12 million shares * 19.5/share = 234 million

Value of debt = 200,000 bonds * 1000 face value/bond * 89% sale price = 178 million

Total firm value = 234 + 178 = 412 million

Weight of equity = 234 / 412 = 0.5680

Weight of debt = 178 / 412 = 0.4320

So, WACC = weight of equity * cost of equity + weight of debt * cost of debt = 0.5680 * 9.275% + 0.4320 * 4% = 7%

So answer is choice C: 7%

Hope this helped ! Let me know in case of any queries.

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