5. Daves, Inc. recently hired you as a consultant to estimate the company\'s WAC

Question

5. Daves, Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's bonds have a yield to maturity of 8%. (2) The company's tax rate is 40%. (3) The firm sells its common stock for $40 per share, and each share pays $1 dividend every year at fixed amount. The floatation cost is 10% (4) The' target capital structure consists of $40 million debt and $40 million common equity. The firm uses Discounted Cash Flow (DCF) model to estimate the cost of equity. What is the firm's weighted average cost of capital (WACC)? (12 points, show all your work to get full credit) Source Debt Common Totals Total Target Value % of Total After-tax Cost 40,000,000 40,000,000 WACC = Additional Bond Data Tax Rate Yield to Maturit 40% 8% Additional Common Data Dividend Price Flotation 1.00 40 0

Explanation / Answer

Weight of debt = 50%

Weight of equity = 50%

After tax cost of debt = 8% × (1 - 40%)

= 4.80%

After tax cost of debt is 4.80%.

Current Stock price = $40

Floatation cost = 10%

Net proceed from sale of equity = $40 × (1 - 10%)

= $36.

COst of equity = $1 / $36

= 2.78%

Cost of equity is 2.78%

Now, WACC = (50% × 4.80%) + (50% × 2.78%)

= 2.40% + 1.36%

= 3.79%

WACC of company is 3.79%.

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