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The company you work for wants you to estimate the company's WACC; but before you do...

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Finance

The company you work for wants you to estimate the company'sWACC; but before you do so, you need to estimate the cost of debtand equity. You have obtained the following information. (1) Thefirm's non-callable bonds mature in 20 years, have an 8.00% annualcoupon, 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 stick's beta is 1.20. (4)The target capital structure consist of 35% debt and the balance iscommon equity. The Firm uses the CAPM to estimate the cost ofequity, and it does not expect to issue any new commonstock.Calculate the company's component cost of debt. DONOT USE EXCEL

Answer & Explanation Solved by verified expert
3.8 Ratings (404 Votes)

Weight of debt = D/A
Weight of debt = 0.35
W(D)=0.35
Cost of debt
                  K = N
Bond Price =? [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N
                   k=1
                  K =20
1225 =? [(8*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^20
                   k=1
YTM = 11.268
After tax cost of debt = cost of debt*(1-tax rate)
After tax cost of debt = 11.268*(1-0.4)
= 6.7608

Weighted cost of debt = weight*cost of debt = 0.35*6.76=2.37%
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Transcribed Image Text

The company you work for wants you to estimate the company'sWACC; but before you do so, you need to estimate the cost of debtand equity. You have obtained the following information. (1) Thefirm's non-callable bonds mature in 20 years, have an 8.00% annualcoupon, 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 stick's beta is 1.20. (4)The target capital structure consist of 35% debt and the balance iscommon equity. The Firm uses the CAPM to estimate the cost ofequity, and it does not expect to issue any new commonstock.Calculate the company's component cost of debt. DONOT USE EXCEL

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