A firm has 2 million common shares outstanding, which are currently trading at $45 per share and have a dividend yield of 10%.The firm also has $40 million of 6% bonds outstanding that are currently trading at 110, with a yield to maturity of 3%.There are no preferred shares and no income taxes.Based on this information what is the WACC?

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Quizplus · Accepted Answer

The Weighted Average Cost of Capital (WACC) is calculated by weighting the cost of each capital component (equity and debt) by its proportion in the firm's capital structure and then summing these results. Equity value = 2 million shares * $45/share = $90 millionDebt value = $40 million (given directly, the trading price does not affect the debt's book value for WACC purposes)Total value = Equity value + Debt value = $90 million + $40 million = $130 millionCost of equity (Ke) = Dividend yield = 10% (since no growth rate or other model specified, we use the given dividend yield)Cost of debt (Kd) = Yield to maturity = 3% (given directly)Equity proportion = Equity value / Total value = $90 million / $130 million = 0.6923Debt proportion = Debt value / Total value = $40 million / $130 million = 0.3077WACC = (Ke * Equity proportion) + (Kd * Debt proportion) = (10% * 0.6923) + (3% * 0.3077) = 6.923% + 0.9231% = 7.8461%Since there are no taxes, we don't adjust the cost of debt for tax savings. Rounding to the nearest option gives us 7.70% as the closest choice.

A Firm Has 2 Million Common Shares Outstanding, Which Are