Jack's Construction Co.has 80,000 bonds outstanding that are selling at par value of £1,000 per bond.Bonds with similar characteristics are yielding 8.5%.The company also has 4 million shares of
Common equity outstanding.The equity has a beta of 1.1 and sells for £40 a share.Treasury bills are
Yielding 4% and the market risk premium is 8%.Jack's tax rate is 35%.What is Jack's weighted
Average cost of capital?

Question

Quizplus · Accepted Answer

- First, we need to calculate the cost of debt: 
   - The bonds are selling at par value, so their coupon rate is the same as the yield to maturity (8.5%).
   - The after-tax cost of debt = (8.5%)*(1-0.35) = 5.53%
- Next, we need to calculate the cost of equity using the CAPM: 
   - r(e) = R(f) + beta*(R(m) - R(f))
   - r(e) = 4% + 1.1*(8%) = 12.8%
- We also need to calculate the weights of debt and equity in the capital structure:
   - Total capital = debt + equity 
   - Debt/total capital = 80,000*1000/[(80,000*1000) + (4,000,000*40)] = 0.1515
   - Equity/total capital = 1 - debt/total capital = 0.8485
- Finally, we can calculate the weighted average cost of capital (WACC):
   - WACC = (weight of debt)*(cost of debt) + (weight of equity)*(cost of equity)
   - WACC = (0.1515)*(5.53%) + (0.8485)*(12.8%) = 10.38%