XYZ Industries has 10 million shares of stock outstanding selling at $10 per share and an issue of $30 million in 8.5 percent, annual coupon bonds with a maturity of 25 years, selling at 102 percent of par ($1,000). If XYZ's weighted average tax rate is 40 percent and its cost of equity is 15 percent, what is XYZ's WACC?
A)8.06 percent
B)11.75 percent
C)12.65 percent
D)13.43 percent

Question

Quizplus · Accepted Answer

Step 1: Calculate the cost of debt
Coupon payment = $30 million x 8.5% = $2.55 million
Current bond price = $1,020
Yield to maturity = (coupon payment / bond price) + ((1000 - 1020) / 25) = 0.0857 + (-0.008) = 0.0777 or 7.77 %
After-tax cost of debt = 7.77% x (1-0.40) = 4.66%

Step 2: Calculate the cost of equity
Cost of equity = 15%

Step 3: Calculate the proportion of equity (E) and debt (D) in the capital structure
Equity:
Market value of equity = 10 million x $10 = $100 million
Proportion of equity = $100 million / ($100 million + $30 million) = 0.7692 or 76.92%

Debt:
Market value of debt = $30 million x 1.02 = $30.6 million
Proportion of debt = $30.6 million / ($100 million + $30.6 million) = 0.2348 or 23.48%

Step 4: Calculate the weighted average cost of capital (WACC)
WACC = (E / V) x Re + (D / V) x Rd x (1 - T)
Where,
E = market value of equity
V = total market value of equity and debt
Re = cost of equity
D = market value of debt
Rd = cost of debt
T = tax rate

WACC = (0.7692) x 0.15 + (0.2348) x 0.0466 x (1 - 0.40) = 0.1188 or 11.88%
Therefore, the WACC is 12.65% (rounded to the nearest hundredth)

XYZ Industries Has 10 Million Shares of Stock Outstanding Selling