Exhibit 9-8
USE THE FOLLOWING INFORMATION IS FOR THE NEXT PROBLEM(S)
At the end of the year 2009 the CKL Corporation had operating free cash flow (OFCF) of $300,000 and shares outstanding of 100,000. Total debt is currently $10,000,000. The company projects the following annual growth rates in OFCF $$\begin{array} { c c }
\text { Year } & \text { Grawth Rate } \
\hline 2010 & 25 \% \
2011 & 20 \% \
2012 & 15 \% \
2013 & 10 \% \
2014 & 12 \% \
2015 & 14 \% \
2016 & 16 \% \
2017 & 198
\end{array}$$
From year 2018 onward growth in OFCF is expected to remain constant at 5% per year. The stock has a beta of 1.1 and the current market price is $80. Currently the yield on 10-year Treasury notes is 5% and the equity risk premium is 4%. The firm can raise debt at a pre-tax cost of 9%. The tax rate is 25%. The proportion of equity is 55% and the proportion of debt is 45%.
-Refer to Exhibit 9-8. Calculate the weighted average cost of capital (WACC).
A) 8.2%
B) 9.4%
C) 9.0%
D) 10.3%
E) 7.3%

Question

Exhibit 9-8
USE THE FOLLOWING INFORMATION IS FOR THE NEXT PROBLEM(S)
At the end of the year 2009 the CKL Corporation had operating free cash flow (OFCF) of $300,000 and shares outstanding of 100,000. Total debt is currently $10,000,000. The company projects the following annual growth rates in OFCF $$\begin{array} { c c } 
\text { Year } & \text { Grawth Rate } \
\hline 2010 & 25 \% \
2011 & 20 \% \
2012 & 15 \% \
2013 & 10 \% \
2014 & 12 \% \
2015 & 14 \% \
2016 & 16 \% \
2017 & 198
\end{array}$$ 
From year 2018 onward growth in OFCF is expected to remain constant at 5% per year. The stock has a beta of 1.1 and the current market price is $80. Currently the yield on 10-year Treasury notes is 5% and the equity risk premium is 4%. The firm can raise debt at a pre-tax cost of 9%. The tax rate is 25%. The proportion of equity is 55% and the proportion of debt is 45%.
-Refer to Exhibit 9-8. Calculate the weighted average cost of capital (WACC).
A) 8.2%
B) 9.4%
C) 9.0%
D) 10.3%
E) 7.3%

Quizplus · Accepted Answer

The weighted average cost of capital (WACC) is calculated using the formula: WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc), where E is the market value of equity, D is the market value of debt, V is the total market value (E + D), Re is the cost of equity, Rd is the cost of debt, and Tc is the corporate tax rate. Given that the proportion of equity is 55% and the proportion of debt is 45%, the cost of equity (Re) can be calculated using the Capital Asset Pricing Model (CAPM): Re = Rf + β*(Rm - Rf), where Rf is the risk-free rate, β is the beta of the stock, and (Rm - Rf) is the equity risk premium. Substituting the given values: Re = 5% + 1.1*(4%) = 9.4%. The after-tax cost of debt (Rd*(1 - Tc)) is 9%*(1 - 0.25) = 6.75%. Therefore, WACC = 0.55*9.4% + 0.45*6.75% = 5.17% + 3.0375% = 8.2075%, which rounds to approximately 8.2%.

Exhibit 9-8 USE THE FOLLOWING INFORMATION IS FOR THE NEXT

Exhibit 9-8
USE THE FOLLOWING INFORMATION IS FOR THE NEXT