A. BlockOut Co. has 78,543 bonds outstanding that are selling at par value. The

Question

A.

BlockOut Co. has 78,543 bonds outstanding that are selling at par value. The bonds yield 8.2 percent. The company also has 5.2 million shares of common stock outstanding. The stock has a beta of 1.15 and sells for $43.3 a share. The U.S. Treasury bill is yielding 4.5 percent and the market risk premium is 8.8 percent. Blackout's tax rate is 34 percent. What is the firm's weighted average cost of capital? (Enter answer in percents.)

B.

Dominosa, Inc. wants to have a weighted average cost of capital of 7.3 percent. The firm has an aftertax cost of debt of 5.7 percent and a cost of equity of 10.5 percent. What debt-equity ratio is needed for the firm to achieve their targeted weighted average cost of capital?

C.

Information on Inkscape Co., is shown below. Assume the company's tax rate is 33 percent. The firm has no debt.
Common stock: 227,459 shares outstanding, selling for $81.1 per share; beta is 1.24.
Preferred stock: 27,773 shares of 4 percent preferred stock outstanding, currently selling for $89.2 per share.
Market: 8.52 percent market risk premium and 3.65 percent risk-free rate.
Calculate the WACC. Enter answer in percents.

Explanation / Answer

Solution for question A

Number of bond = 78,543

Price of bond = $1,000

Market value of total debt = 78,543 × $1,000

                                           = $78,543,000

Number of stock outstanding = 5,200,000

Price of stock = $43.3

Market value of stock = 5,200,000 × $43.3

                                    = $225,160,000

Weight of debt in capital structure = $78,543,000 / ($78,543,000 + $225,160,000)

                                                        = 25.86%

Similarly

Weight of equity in capital structure = $225,160,000 / ($78,543,000 + $225,160,000)

                                                           = 74.14%

Cost of debt

Yield on bond = 8.20%

Tax rate = 34%

After tax cost of debt = 8.20% × (1 – 34%)

                                   = 5.412%

After tax cost of debt is 5.412%

Cost of equity

Risk free rate = 4.5%

Risk Premium = 8.8%

Beta = 1.15

Expected rate of return is calculated below using CAPM formula:

Expected rate of return = Risk free rate + Risk Premium × Beta

                                      = 4.5% + 8.8% × 1.15

                                      = 4.5% + 10.12%

                                      = 14.62%

Cost of equity of company stock is 14.62%.

WACC

Now calculate WACC of company as calculated below:

WACC = 74.14% × 14.62% + 25.86% ×5.412%

             = 10.84% + 1.40%

             = 12.24%

Hence, WACC of company is 12.24%.

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