Droz\'s Hiking Gear, Inc. has found that its common equity capital shares have a

Question

Droz's Hiking Gear, Inc. has found that its common equity capital shares have a beta equal to 2.25 while the risk-free return is 9 percent and the expected return on the market is 15 percent. It has 8-year semiannual maturity bonds outstanding with a price of $1,150 that have a coupon rate of 8 percent. The firm is financed with $150 million of common shares (market value) and $80 million of debt. What is the after-tax weighted average cost of capital for Droz's, ifit is subject to a 35 percent marginal tax rate? Round your final percentage answer to three decimal places.

Explanation / Answer

Re = Rf + Beta*(Rm - Rf)

Re = 9% + 2.25*(15%-9%) = 22.5%

Rb = =2*RATE(8*2,1000*8%/2,-1150,1000) = 5.644%

We = 150/(150+80) = 150/230 = 65.217%

Wd = 1 - We = 34.783%

WACC = Wd*Rd*(1-T) + We*Re

= 34.783%*5.644%*(1-35%) + 65.217%*22.5%

= 15.950%

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