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Please show full work if possible, would like to be able tounderstand the problem and solution.
Lion Inc. recently hire you as a consultant to estimate thecompany’s WACC. You have
obtained the following information.
(1) The firm’s noncallable bonds mature in 20 years, have an 8%annual coupon, a par
value of $1,000, and a market price of $1,050.
(2) The company’s tax rate is 40%.
(3) The risk-free rate is 4.50% and the market risk premium is5.50%. The stock has a
beta of 1.20.
(4) The target capital structure consists of 35% debt and theremainder is common
stock.
(5) The firm uses the CAPM to estimate the cost of equity, andit does not expect to
issue any new common stock.
Please identify the company’s WACC
A. 7.16%
B. 7.54%
C. 7.93%
D. 8.35%
E. 8.79%

Answer & Explanation Solved by verified expert

4.1 Ratings (601 Votes)

Weight of equity = 1-D/A

Weight of equity = 1-0.35

W(E)=0.65

Weight of debt = D/A

Weight of debt = 0.35

W(D)=0.35

Cost of equity

As per CAPM

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

Cost of equity% = 4.5 + 1.2 * (5.5)

Cost of equity% = 11.1

Cost of debt

K = N

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

k=1

K =20

1050 =? [(8*1000/100)/(1 + YTM/100)^k] + 1000/(1 + YTM/100)^20

k=1

YTM = 7.5091959827

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

After tax cost of debt = 7.5091959827*(1-0.4)

= 4.50551758962

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

WACC=4.51*0.35+11.1*0.65

WACC =8.79%

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Please show full work if possible, would like to be able tounderstand the problem and solution.Lion Inc. recently hire you as a consultant to estimate thecompany’s WACC. You haveobtained the following information.(1) The firm’s noncallable bonds mature in 20 years, have an 8%annual coupon, a parvalue of $1,000, and a market price of $1,050.(2) The company’s tax rate is 40%.(3) The risk-free rate is 4.50% and the market risk premium is5.50%. The stock has abeta of 1.20.(4) The target capital structure consists of 35% debt and theremainder is commonstock.(5) The firm uses the CAPM to estimate the cost of equity, andit does not expect toissue any new common stock.Please identify the company’s WACCA. 7.16%B. 7.54%C. 7.93%D. 8.35%E. 8.79%