7. Joe’s Pizza-In-A-Cup recently hired you as a consultant to estimate the company’s WACC. You have...

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7. Joe’s Pizza-In-A-Cup recently hired you as a consultant toestimate the company’s WACC. You have obtained the followinginformation. (1) The firm's noncallable bonds mature in 10 years,have an 6.00% annual coupon, a par value of $1,000, and a marketprice of $1,100.00. (2) The company’s tax rate is 40%. (3) Therisk-free rate is 4.00%, the market risk premium is 5.00%, and thestock’s beta is 1.20. (4) The target capital structure consists of45% debt and the balance is common equity. The firm uses the CAPMto estimate the cost of equity, and it does not expect to issue anynew common stock. What is its WACC? Do not round your intermediatecalculations.

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3.9 Ratings (639 Votes)

Weight of equity = 1-D/A

Weight of equity = 1-0.45

W(E)=0.55

Weight of debt = D/A

Weight of debt = 0.45

W(D)=0.45

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 4 + 1.2 * (5)

Cost of equity% = 10

Cost of debt

K = N

Bond Price =? [(Annual Coupon)/(1 + YTM)^k] + Par value/(1 + YTM)^N

k=1

K =10

1100 =? [(6*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^10

k=1

YTM = 4.7223575927

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 4.7223575927*(1-0.4)

= 2.83341455562

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=2.83*0.45+10*0.55

WACC =6.77%

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Transcribed Image Text

7. Joe’s Pizza-In-A-Cup recently hired you as a consultant toestimate the company’s WACC. You have obtained the followinginformation. (1) The firm's noncallable bonds mature in 10 years,have an 6.00% annual coupon, a par value of $1,000, and a marketprice of $1,100.00. (2) The company’s tax rate is 40%. (3) Therisk-free rate is 4.00%, the market risk premium is 5.00%, and thestock’s beta is 1.20. (4) The target capital structure consists of45% debt and the balance is common equity. The firm uses the CAPMto estimate the cost of equity, and it does not expect to issue anynew common stock. What is its WACC? Do not round your intermediatecalculations.