21) Fiscal Cliff Inc. has a capital structure that consists of 15 percent common

Question

21) Fiscal Cliff Inc. has a capital structure that consists of 15 percent common stock and 85 percent long-term debt. E 21) F nfote Fiscal Cliff's weighted average cost of capital, an analyst has accumulated the following information: . The company currently has 15-year bonds outstanding with annual coupon payments of 9 percent. The bonds have a face value of $1,000 and sell for $700. The risk-free rate is 2.5 percent. The market risk premium is 7 percent. The beta on Fiscal Cliff's common stock is 2.2 . . The company's retained earnings are sufficient so that they do not have to issue any new common stock to fund capital projects The company's tax rate is 40 percent Given this information, what is Fiscal Cliffts WACC? A. 11.35% B. 7.28% C. 9.17% D. 8.91% E. 9.75%

Explanation / Answer

WACC = (Weight of Debt*After tax cost of debt)+(Weight of Equity*Cost of Eqity) = (0.85*8.31%)+(0.15*17.90%) = 9.75% Working: a. Before Tax cost of debt = 13.85% = Annual Coupon = $    1,000 x 9% = $          90 Face = fv = $    1,000 Price = pv = $      -700 Maturity = nper = 15 Coupon = pmt = $    90.00 Yield (Before Tax) =Rate(nper,pmt,pv,fv) 13.85% b. After tax cost of debt = Before Tax cost of debt*(1-Tax Rate) = 13.85%*(1-0.40) = 8.31% c. Cost of Equity = Risk Free +Beta*Risk premium = 2.5%+2.2*7% = 17.90%

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