Delta Lighting has 30,000 shares of common stock outstanding at a market price of $17.50 a share. This stock was originally issued at $31 per share. The firm also has a bond issue outstanding with a total face value of $280,000 which is selling for 86 percent of par. The cost of equity is 16 percent while the aftertax cost of debt is 6.9 percent. The firm has a beta of 1.48 and a tax rate of 30 percent. What is the weighted average cost of capital?

Question

Quizplus · Accepted Answer

Step 1: Calculate the market value of equity
Market value of equity = 30,000 x $17.50 = $525,000
Step 2: Calculate the market value of debt
Market value of debt = $280,000 x 0.86 = $240,800
Step 3: Calculate the total market value of the firm
Total market value = $525,000 + $240,800 = $765,800
Step 4: Calculate the weight of equity
Weight of equity = $525,000 / $765,800 = 0.6852
Step 5: Calculate the weight of debt
Weight of debt = $240,800 / $765,800 = 0.3148
Step 6: Calculate the cost of equity using CAPM
Cost of equity = risk-free rate + beta x (market return - risk-free rate)
Cost of equity = 0.069 + 1.48 x (0.16 - 0.069)
Cost of equity = 0.2024 or 20.24%
Step 7: Calculate the aftertax cost of debt
Aftertax cost of debt = 0.069 x (1 - 0.3)
Aftertax cost of debt = 0.0483 or 4.83%
Step 8: Calculate the weighted average cost of capital
WACC = (weight of equity x cost of equity) + (weight of debt x aftertax cost of debt)
WACC = (0.6852 x 0.2024) + (0.3148 x 0.0483)
WACC = 0.1393 or 13.93%
Therefore, the best choice is B, the weighted average cost of capital is 13.14 percent.

Delta Lighting Has 30,000 Shares of Common Stock Outstanding at a Market