The total book value of WTC’s equity is $10 million, and book value per share is $20. The stock has a market-to-book ratio of 1.5, and the cost of equity is 15%. The firm’s bonds have a face value of $5 million and sell at a price of 110% of face value. The yield to matu- rity on the bonds is 9%, and the firm’s tax rate is 40%. Find the company’s WACC. (LO13-1)

12.88%

Explanation:

The formula to compute the WACC is shown below:

= Weightage of debt × cost of debt × ( 1- tax rate) + ((Weightage of  common stock) × (cost of common stock)

where,

Market Value of Equity is

= Book Value of Equity × Market to book ratio

= $10 million × 1.5

= $15 million.

Market value of debt = Face Value × Percentage of par value

= $5 million × 110%

= $5.50 million

Now

Weight of debt = Debt ÷ (Debt + Equity)

                         = $5.50 ÷ ($5.50 + $15)

                         = 26.83%

And,

Weight of equity = Equity ÷ (Debt + Equity)

                            = $150 ÷ ($5.50 + $15)

                            = 73.17%

Now the WACC is

= 26.83% × 9% × (1 - 21%) + (73.17% × 15% )

= 1.91% + 10.98

= 12.88%

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