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Jack's Construction Co. has 80,000 bonds outstanding that are selling at par value. Bonds with similar characteristics are yielding 8.6 percent. The company also has 4 million shares of common stock outstanding. The stock has a beta of 1.1 and sells for $40 a share. The U.S. Treasury bill is yielding 4 percent and the market risk premium is 8 percent. Jack's tax rate is 34 percent. What is Jack's weighted average cost of capital?

Respuesta :

TomShelby

Answer:

WACC 10.42614%

Explanation:

First we use CAPM to solve for the cost of equity

[tex]Ke= r_f + \beta (r_m-r_f)[/tex]  

risk free 0.04

market rate  

premium market (market rate - risk free) 0.08

beta(non diversifiable risk) 1.1

 

[tex]Ke= 0.04 + 1.1 (0.08)[/tex]  

Ke 0.12800

Then we calculate the WACC (weighted average cost of capital)

[tex]WACC = K_e(\frac{E}{E+D}) + K_d(1-t)(\frac{D}{E+D})[/tex]

D 80,000 bonsd x 1,000 = 80,000,000

E 4,000,000 shares x 40 = 160,000,000

E+ D 80,000,000 + 160,000,000 = 240,000,000

equity weight: 2/3

liability weight: 1/3

Ke 0.128

Equity weight 0.6667

Kd 0.086

Debt Weight 0.3334

t 0.34

[tex]WACC = 0.128(0.6667) + 0.086(1-0.34)(0.3334)[/tex]

WACC 10.42614%