Bolster Foods' (BF)balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%.The yield to maturity on this debt is 8.00%,and the debt has a total current market value of $27 million.The balance sheet also shows that the company has 10 million shares of stock,and the stock has a book value per share of $5.00.The current stock price is $20.00 per share,and stockholders' required rate of return,r_s,is 12.25%.The company recently decided that its target capital structure should have 35% debt,with the balance being common equity.The tax rate is 40%.Calculate WACCs based on book,market,and target capital structures,and then find the sum of these three WACCs.

Question

Quizplus · Accepted Answer

1. WACC based on book capital structure (B) = [(D/D+E) x rD x (1 - TC)] + [(E/D+E) x rE)]
= [(25/25+50) x 8.50% x (1-0.40)] + [(50/25+50) x 12.25%]
= 4.44% + 9.22%
= 13.66%

2. WACC based on market capital structure (M) = [(D/D+E) x rD x (1 - TC)] + [(E/D+E) x rE)]
= [(27/27+50) x 8.50% x (1-0.40)] + [(50/27+50) x 12.25%]
= 4.23% + 8.75%
= 12.98%

3. WACC based on target capital structure (T) = [(D/D+E) x rD x (1 - TC)] + [(E/D+E) x rE)]
= [(35/35+65) x 8.00% x (1-0.40)] + [(65/35+65) x 12.25%]
= 2.88% + 10.64%
= 13.52%

Sum of the three WACCs = 13.66% + 12.98% + 13.52% = 40.16%
Average WACC = 40.16%/3 = 13.39%

Based on the calculations, the best choice is C because it is the closest to the average WACC.

Bolster Foods' (BF)balance Sheet Shows a Total of $25 Million