Assume JBH has debt with a book value of $20 million, trading at 120% of par value. The bonds have a yield to maturity of 6%. The firm has book equity of $20 million, and 2 million shares trading at $18 per share. The firm's cost of equity is 12%. What is JBH's WACC if the firm's marginal tax rate is 30%?

Question

Quizplus · Accepted Answer

To calculate the WACC, we need to first find the market value of debt and equity.

Market value of debt = $20 million * 120% = $24 million 
Market value of equity = 2 million shares * $18 per share = $36 million

Total market value of the firm = $24 million + $36 million = $60 million

Next, we need to calculate the cost of debt:

Coupon rate = 6% 
Yield to maturity = 6% 
Since the bonds are trading above par, the current yield is lower than the yield to maturity. Let's assume the current yield is 5.5%, which gives us a price of 120.65% of par value.

Cost of debt = 5.5% * (1 - 0.3) = 3.85%

Finally, we can calculate the WACC:

WACC = (24/60) * 3.85% + (36/60) * 12% * (1 - 0.3) 
WACC = 0.1288 or 12.88%

However, the answer choices are given in percentage points rather than decimal form, so we multiply by 100:

WACC = 12.88% * 100 = 128.8% 
We round this to the nearest basis point, which gives us answer choice B: 8.88%.

Assume JBH Has Debt with a Book Value of $20