Bouncing Baby Foods\' (BBF) balance shed shows a total of $20 million long-term
ID: 2767545 • Letter: B
Question
Bouncing Baby Foods' (BBF) balance shed shows a total of $20 million long-term debt with a coupon rate of 8.00 percent. The yield to maturity on this debt is 10.00 percent, and the debt has a total current market value of $17.5 million. The balance sheet also shows that that the company has 10 million shares of stock, and total of common equity (common stock plus retained earnings; is $30 million I he current stock price is $3.50 per share, and stockholders' required rate of return, r_s, is 12.47 percent. The company has no preferred stock outstanding. The company recently decided that its target capital structure should have 50% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on target, book, and market value capital structures.Explanation / Answer
step-1 : Introduction
To calculate weighted average cost of capital we need weights and cost of capital for equity and debt.
As per the given information, we have cost of equity = 12.47%
and cost of debt = interest rate (1-tax rate) = 8% *1-40%) = 8% * 0.6 = 4.8%
weights = proportion of debt and equity in the capital structure
Step-2: Computation of WACC based on book values:
Therefore, WACC based on book value = 0.09402 = 9.4%
Computation of WACC based on Market values:
Therefore, WACC based on Market value = 0.099389 = 9.9%
Computation of WACC based on Target values: Under Target value weights i.e, proportions are already given that means 50% of debt and equity.
Therefore, WACC based on Target value = 0.08635 = 8.6%
Particulars After Tax Cost of Capital Book Value Proportion WACC=cost of capital * proportion
Debt 4.8% $20 million 20/50 = 0.4 4.8% * 0.4 = 0.0192 Equity 12.47% $30 million 30 /50=0.6 12.47% * 0.6 =0.07482 Total $50 million 100% = 1 0.09402
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