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Calculating the Cost of Debt and WACC Some problems in this chapter may require many...

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Finance

Calculating the Cost of Debt and WACC

Some problems in this chapter may require many steps. For example, you might solve for the cost of debt or the cost of equity and this use this information to then find WACC. In another example, you might solve for the capital structure weights and then use them to find the WACC.

Practice an example below that includes two steps.

"A firm is considering a new project that will require an initial outlay of $20 million. It has a target capital structure of 50% debt, 8% preferred stock, and 42% common equity. The firm has non-callable bonds that mature in five years with a face value of $1,000, an annual coupon rate of 8%, and a market price of $1080.64. The yield on the companys current bonds is a good approximation of the yield on any new bonds that are issued. The cost of preferred stock for the firm is 12.5% and the cost of common equity is 14%. The firm has a marginal tax rate of 35%. Determine the firms WACC for this project"

Step 1. Find the cost of debt (the yield to maturity on outstanding bonds)

Step 2. Input all of the necessary variables into the WACC equation

8.86%

9.92%

10.83%

8.00

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