Dakota, Inc., want you to find the cost of capital (WACC). Information is given

Question

Dakota, Inc., want you to find the cost of capital (WACC). Information is given regarding the cost of capital.

Debt: Dakota’s bonds have a coupon rate of 6% and 20 years to maturity. The current value of the bond is $802.07. The coupon is paid semiannually. The tax rate is 40%.

Common Equity: Dakota’s stock will use CAPM. The beta is 1.1 and the risk-free rate is 4%. The market risk premium is 9%.

Dakota has a capital structure of 40% debt and 60% common equity.

1. Find the cost of debt after-tax.

2. Find the cost of equity.

3. Find the WACC for Dakota.

Explanation / Answer

1. Cost of Debt after tax = Yield to Maturity of the bond * (1 - Tax rate)

YTM = RATE(no of coupons, coupon, present value of bond, final payment) = rate(40,30,-802.07,1000) = 4%

Cost of debt after-tax = 4% * (1 - 0.40) = 4% * 0.60 = 2.4%

2. As per CAPM, Cost of equity = risk free rate + Beta * Market risk premium = 4% + 1.1*9% = 13.9%

3. WACC = weighted average cost of capital = 40% * 2.4% + 60% * 13.9% = 0.96% + 8.34% = 9.3%

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