Jake the Dog, Inc is investing in a new portable iguana killing machining that w
ID: 2727144 • Letter: J
Question
Jake the Dog, Inc is investing in a new portable iguana killing machining that will cost $200,000. The machine has a useful life of 6 years and falls in the 5-year property class of the depreciation purposes. The IRS MACRS schedule for the six years is (1) 20% (2) 32% (3) 19.2% (4) 11.52% (5) 11.52% (6) 5.76%. It will generate $50,000 per years of savings for Jake and can be sold for $50,000 at the end of the 6-year period, Jake's corporate tax rate is 34%. In addition, Jake has 2000 outstanding 9% annual coupon bonds with a $1000 par value. 20 years to maturity and a price of $1085. Jake also has 60,000 shares of common stock outstanding that is selling for $45 per share. This stock has a beta of 2.45, the expected market return is 12% and the risk-free rate is 5%. Finally, Jake has 36,000 shares preferred stock outstanding that pays a 5.5% divided and sells for $40 per share. What is Jake's WACC?
Explanation / Answer
Ans:
Calculation of WACC:
Machine cost = $200,000
Machine Use full years = 6 years
Every generate savings = $50,000
Total savings in 5 years = $250,000 + sold in 6th year
= $250,000 + $50,000
= $300,000
Calculation of Cost of equity:
re
=
rf
+
×
(rm rf)
= 5 + 2.45 * (12 – 5)
= 5 + 17.15
= 22.15
Jake has 60,000 shares @ 45 per share
= $2,700,000
Outstanding = $2,000
Jake has 36,000 share @ 40 per share
= $1,440,000
Outstanding pays = 5.5 %
= 1,440,000 * 5.5
$79,200
Calculation of yield to maturity:
Bond par value = $1000
Coupon rate = 9%, period = 20years
Price = $1085
Calculating WACC can be expressed in the following formula:
Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm's equity
D = market value of the firm's debt
V = E + D = total market value of the firm’s financing (equity and debt)
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate
= $2,700,000/$4,140,000 * $45 + $1,440,000 / $4,140,000 * $40 (1-0.34)
= 0.652 * $45 + 0.347 * $40 (0.66)
= $29.34 + $13.88 (0.66)
= $38.5008
re
=
rf
+
×
(rm rf)
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