Hi, I am having trouble with this problem. I would like to understand how it is
ID: 2772702 • Letter: H
Question
Hi, I am having trouble with this problem. I would like to understand how it is solved if you wouldn't mind showing the steps and a little explanation that would be great! Thank you! I will leave positive feedback!
Jack’s Construction Co. (JCC) has 80,000 bonds outstanding that are currently selling at par (face) value. Bonds with similar characteristics are currently yielding 8.5%. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is currently yielding 4% and the market risk premium is 8%. The corporate tax rate is 35%.
Use this information to answer sections (a) - (e).
a. What is JCC's after-tax cost of debt?
b. What is JCC's cost of equity?
c. What is the proportion (weight) of debt in JCC's capital structure?
d. What is the proportion (weight) of equity in JCC's capital structure?
e. What is JCC's WACC?
Explanation / Answer
Answer-a:
Calculation of after tax cost of debt:
After tax cost of debt = Interest rate * (1-tax rate)
= 8.5% * (1-35%)
=5.53%
Answer-b:
Calculation of Cost of Equity :
Cost of Equity = Risk free rate + (Beta * Market risk premium)
=4% + (1.1*8%)
= 12.80%
Answer-c:
Calculation of Weight of Debt:
Weight of Debt = Debt /(Debt + Equity)
= (80000*1000) / ((80000*1000) + (4000000*40))
= 80000000 / (80000000 + 160000000)
= 0.3333
=33.33%
Answer-d:
Calculation of weight of Equity :
Weight of Equity = 1- weight of debt
=1-0.3333
= 0.6667
= 66.67%
Answer-e:
Calculation of WACC:
WACC = (After tax Cost of Debt * weight of Debt ) + (Cost of Equity * weight of Equity )
= (5.53% *33.33%) + (12.80% * 66.67%)
= 10.38%
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