A friend that has a mid-sized company has hired you and she would like to use you as a consultant. She wants you to calculate the WACC for her firm. She gives you the following information:DebtThe firm has face value of $150,000,000 outstanding of zero coupon debt that has a yield to maturity of 4.20%.EquityThe firm has stock with 70 million shares outstanding, a tax rate of 35%, and a beta of 1.2. The firm is expected to pay a dividend of $2.40 next year and it is expected to grow by 4% for the foreseeable future. The expected return on the market is 5% and the risk free rate is 1.50%.What is the WACC of the company?
Please show all work/calculations
Hi, Thanks for using Just Answer. I will be working on it and post you a solution soon.
Hi, are you given the duration of the zero coupon bond?
or the market value of the bond?
That is all that is provided, you can make assumptions as long as they are stated somewhere.
To find the WACC, we need to find the weighted average of debt and equity. The cost of debt would be after-taxed. Since we are not given the market value of hte debt, I am going to use the face value (the given value). Weight of debt = 150/220; cost of debt = 4.2%; tax rate = 35%; weight of equity = 70/220; cost of equity = 1.5%+1.2(5%-1.5%) = 5.7%WACC = (150/220)(4.2%) (1-35%) + (70/220)(5.7% ) = 3.675%
(I used the CAPM model to find the cost of equity in this problem.)
So is this the formula that you used?
Hmm.. For the CAPM, it is risk free rate + beta(Market premium) = cost of equity = 1.5%+1.2(5%-1.5%) = 5.7%
As for the WACC, it is weight of debt (cost of debt)(1-tax rate) + weight of equity(cost of equity)
Great, thank you so much. I have other questions waiting to be answered if you can go in and look at them for me.
I have to go for lunch now. If they are not answered when I return, I'll answer them.
CFA Level 2 Candidate