Sans Souci Trucking\'s balance sheet shows a total of noncallable $40 million lo

Question

Sans Souci Trucking's balance sheet shows a total of noncallable $40 million long-term debt with a coupon rate of 6.50% and a yield to maturity of 7.00%. This debt currently has a market value of $38.595 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $60 million. The current stock price is $30.00 per share; stockholders' required return, rs, is 12.00%; and the firm's tax rate is 40%. 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 these two WACCs?

Explanation / Answer

Debt as per book 40m@6.5% 40m Debt as per market 38.595 m@7% 38.595m Share as per book 60m 60m Share as per market 10m*30=300m 300m Required rate of return on share 12% Tax Rate 40% WACC as per book weights =(40*(1-0.4)*6.5+60*12)/(40+60) 8.76 WaCC as per market weights=(38.595*(1-0.4)*7.0+300*12)/(38.595+300) 11.111 Difference between the two WACC=11.111-8.76 2.351

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