JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent, annual coupon bonds with a maturity of 15 years, selling at 108 percent of par ($1,000). If JAK's weighted average tax rate is 21 percent and its cost of equity is 15 percent, what is JAK's WACC?
A) 9.19 percent
B) 12.59 percent
C) 12.50 percent
D) 12.77 percent

Question

Quizplus · Accepted Answer

To calculate JAK Industries' Weighted Average Cost of Capital (WACC), we need to find the weights and costs of equity and debt, and then apply the tax shield on the cost of debt.1. **Equity (E):**   - Market value of equity = Number of shares * Price per share = 5 million * $25 = $125 million.2. **Debt (D):**   - Market value of debt = Issue price as a percentage of par * Total value of bonds = 108% * $40 million = $43.2 million.3. **Total Value (V):**   - V = E + D = $125 million + $43.2 million = $168.2 million.4. **Weights:**   - Weight of equity (W_e) = E/V = $125 million / $168.2 million = 0.743 or 74.3%.   - Weight of debt (W_d) = D/V = $43.2 million / $168.2 million = 0.257 or 25.7%.5. **Cost of Equity (R_e):**   - Given as 15%.6. **Cost of Debt (R_d) before tax:**   - The annual coupon is 8% of the par value, so $80 per bond. Since the bonds are selling at 108% of par, the yield (cost of debt before tax) is $80 / $1080 = 0.0741 or 7.41%.7. **After-tax Cost of Debt (R_d after tax):**   - R_d after tax = R_d * (1 - Tax rate) = 7.41% * (1 - 0.21) = 5.85%.8. **WACC:**   - WACC = (W_e * R_e) + (W_d * R_d after tax) = (0.743 * 15%) + (0.257 * 5.85%) = 11.205% + 1.503% = 12.708%.Rounding to two decimal places, the closest answer is 12.77 percent, which is not among the provided options based on the calculation. However, the correct approach to solving the problem was demonstrated. Given the options, the closest and technically correct choice based on standard rounding rules would be 12.59 percent, but this acknowledges a discrepancy in the final calculation step or a potential misunderstanding in the provided options.

JAK Industries Has 5 Million Shares of Stock Outstanding Selling