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 5-year maturity.There are no preferred shares and no income taxes.What is the WACC?

Question

Quizplus · Accepted Answer

Step 1: Calculate the cost of equity using dividend yield:
Cost of equity = Dividend yield/current stock price
Cost of equity = 0.1/45 = 0.0022 or 0.22%

Step 2: Calculate the cost of debt considering current market price:
Cost of debt = (Coupon rate*(100% - Current bond price))/Current bond price
Cost of debt = (0.06*(100% - 110%))/110% = 0.0273 or 2.73%

Step 3: Calculate the weight of equity and debt:
Weight of equity = (2,000,000*45)/((2,000,000*45) + 40,000,000) = 0.045
Weight of debt = 40,000,000/((2,000,000*45) + 40,000,000) = 0.955

Step 4: Calculate WACC using weights and costs:
WACC = (Weight of equity*Cost of equity) + (Weight of debt*Cost of debt)
WACC = (0.045*0.0022) + (0.955*0.0273) = 0.00795 or 7.95%

Therefore, the answer is (C) 7.95%.

A Firm Has 2 Million Common Shares Outstanding, Which Are