Here is some information about Stokenchurch Inc.:

Beta of common stock = 2.1

Treasury bill rate = 4%

Market risk premium = 8.4%

Yield to maturity on long-term debt = 7%

Book value of equity = $530 million

Market value of equity = $1,060 million

Long-term debt outstanding = $1,060 million

Corporate tax rate = 35% 

What is the company's WACC? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

 

Answer:

(I) Weights:

Total market value of the capital structure = MV of debt + MV of equity

Total market value of the capital structure =1 060 million + 1060 million =2120 million

Weight of debt= 1060/ 2120 =0.5

Weight of equity=1060/ 2120 =0.5

II. Costs:

Debt

The YTM for the coupon bonds is the before-tax cost of debt.=7%

After tax cost of debt=YTM * (1- tax rate) =7% * (1-0.35)=4.55%

Equity

As per CAPM , Cost of equity= Risk Free rate T-bill + Beta * Market Risk Premium = 4%+ 1.2 *8.4% =21.64%

Thus

The WACC for the company. = Weight of debt * After tax cost of debt+ Weight of equity * Cost of equity

WACC= 0.50* 4.55%+ 0.50* 21.64%=13.095%

The company's WACC=13.10%