Granby Foods' (GF)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 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.What is the sum of these three WACCs?

Question

Quizplus · Accepted Answer

First, we need to calculate the book value and market value of the company's debt and equity:
Book value of debt = $25 million
Market value of debt = $27 million
Book value of equity = 10 million shares * $5.00 per share = $50 million
Market value of equity = 10 million shares * $20.00 per share = $200 million

Now, we can calculate the WACC based on book capital structure:
Debt weight = $25 million / ($25 million + $50 million) = 0.3333
Equity weight = $50 million / ($25 million + $50 million) = 0.6667
After-tax cost of debt = 8.50% * (1 - 0.40) = 5.10%
Cost of equity = 12.25%
WACC book = (0.3333 * 5.10%) + (0.6667 * 12.25%) = 9.77%

Next, we can calculate the WACC based on market capital structure:
Debt weight = $27 million / ($27 million + $200 million) = 0.1185
Equity weight = $200 million / ($27 million + $200 million) = 0.8815
After-tax cost of debt = 8.00% * (1 - 0.40) = 4.80%
Cost of equity = 12.25%
WACC market = (0.1185 * 4.80%) + (0.8815 * 12.25%) = 10.79%

Finally, we can calculate the WACC based on target capital structure:
Debt weight = 0.35
Equity weight = 0.65
After-tax cost of debt = 8.00% * (1 - 0.40) = 4.80%
Cost of equity = 12.25%
WACC target = (0.35 * 4.80%) + (0.65 * 12.25%) = 9.37%

The sum of these three WACCs is: 9.77% + 10.79% + 9.37% = 30.77%. Therefore, the best choice is C) 30.77%.

Granby Foods' (GF)balance Sheet Shows a Total of $25 Million