Daves Inc. recently hired you as a consultant to estimate the company\'s WACC. Y

Question

Daves Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $925.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC?

a. 11.24% b. 9.25% c. 8.07% d. 9.52% e. 9.07%

Explanation / Answer

Calculating the YTM using excel sheet:
Select function in that finance and then Enter the values as Nper = 20; PMT = -80; PV = 1050; FV = -1000 then you get the value "7.51%"(YTM)
YTM is the pre-tax cost of debt so calculate the value of after-tax cost of debt:
After-tax cost of debt = Pre-tax cost of debt (1 - Tax rate)
= 7.51% (1-0.40)
= 0.0751 (0.60)
= 0.04506 or 4.506%
Calculating the cost of equity using CAPM :
Re = Rf + Beta [E(Rm) - Rf]
= 0.045 + 1.20 [0.055]
= 0.045 + 0.066
= 0.111 or 11.1%
Therefore, the cost of equity is 11.1%
Calculating WACC from the following equation:
WACC = Wd * Rd + We * Re
Wd is the weight of debt
Rd is the after-tax cost of debt
We is the weight of equity
Re is the Cost of equity
WACC = 0.35 * 0.04506 + 0.65 * 0.111
= 0.01577 + 0.07215
= 0.08792 or 8.79%
Therefore, the weighted average cost of capital is 8.79%
You not give full question in point 4 please check it once

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