FINANCE ON THE WEB Table 196 is a simplified book balance sheet for Devon Energy

Question

FINANCE ON THE WEB Table 196 is a simplified book balance sheet for Devon Energy in September 2014. Here is some further information: Number of outstanding shares M Price per share (n Beta 409.1 milion 568 Treasury bill rate 20) year Treasury Cost of debd Marginal tax rate 154 002% 2.01% 430% 2% a Calculate Devon's WACC. Use the capital asset pricing model and the additional infor mation given above. Make additional assumptions and approximations as necessary b. What is Devon's opportunity cost of capital? c. Finally, go to finance yaboo.com and update your answers to questions (0 and (bl. 5.994 10,161 12.508 Shareholders' equity22,176 Current assets property, and equipment Investments and othor assets Total TABLE 19.6 Simplified book balance sheet for Devon Energy, September 2014 (figures in $ millions)

Explanation / Answer

a. Cost of equity = risk free rate + beta*(rm - rf).

rf = 20 year treasury bond rate - treasury bill rate = 3.01-0.02 = 2.99%

As market risk premium is not given we assume it to be 6%

This cost of equity = 2.99%+1.54*6 = 12.23%

After tax cost of debt = 4.70*(1-35%) = 3.06%

Now, market value of equity = market price per share*no. of outstanding shares = 409.1 million*$68 = $27,818.80 million

Weight of equity = market value of equity/(market value of equity+long term debt) = 27818.8/(27818.8+10161) = 0.73

Thus weight of debt = 1-0.73 = 0.27

WACC = weight of equity*cost of equity + weight of debt*cost of debt = 0.73*12.23 + 0.27*3.06 = 9.78%

b. Opportunity cost of capital = weight of debt*before tax cost of debt + weight of equity*cost of equity

= 0.27*4.7 + 0.73*12.23

= 10.22%

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