Question

Daves Inc. recently hired you as a consultant to estimate the company's WACC. You have obtained the following information. (1) The firm's noncallable bonds mature in 20 years, have an 8.00% annual coupon, a par value of $1,000, and a market price of $1,225.00. (2) The company's tax rate is 40%. (3) The risk-free rate is 4.50%, the market risk premium is 5.50%, and the stock's beta is 1.20. (4) The target capital structure consists of 35% debt and the balance is common equity. The firm uses the CAPM to estimate the cost of equity, and it does not expect to issue any new common stock. What is its WACC

Answer 1

Answer:

Weighted Average Cost of Capital (WACC) is  8.9 %

Explanation:

Weighted Average Cost of Capital (WACC) is the minimum return that a project must offer before it can be accepted.

Thus said, Projects are financed from a joined pool of funds that include Sources in the Capital Structure.

The Market Values and the Costs used in Calculation of WACC

Capital Source                 Weight                       Cost                       Total

Noncollectable Bonds        35 %                        4.8%                     1.68%

Equity                                   65 %                       11.1%                      7.22%

Total                                    100%                                                     8.9 %

Cost of Noncollectable Bonds    

Interest has a tax shield therefor include the after tax cost of the the Bond interest

Cost of Bonds = 8.00% × 60%

                        = 4.80%

Cost of Equity

CAPM  = Risk Free Rate + Company`s Beta × Market Premium

            = 4.50 % +(1.20× 5.50%)

            = 11.1 %