Here is some information about Stokenchurch Inc.: Beta of common stock = 1.2 Treasury bill rate = 4% Market risk premium = 7.5% Yield to maturity on long-term debt = 6% Book value of equity = $440 million Market value of equity = $880 million Long-term debt outstanding = $880 million Corporate tax rate = 35% What is the company’s WACC?

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Question:

Here is some information about Stokenchurch Inc.: Beta of common stock = 1.2 Treasury bill rate = 4% Market risk premium = 7.5% Yield to maturity on long-term debt = 6% Book value of equity = $440 million Market value of equity = $880 million Long-term debt outstanding = $880 million Corporate tax rate = 35% What is the company’s WACC?

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Answer:8.45%Explanation:Firstly, we need to calculate cost of equity using capital asset pricing model:Cost of equity = Risk-free rate + Beta x Market risk premium                          = 4% + 1.2 x 7.5% = 13%Then, The weight average cost of capital (WACC) is stated as:WACC = Debt contribution to capital structure x Cost of debt x (1 - tax rate) + Equity contribution capital structure x Cost of equityNote: Debt and equity contribution is calculated using market valuesPutting all the number together, we have:WACC = [880/(880+880)] x 6% x (1 - 35%) + [880/(880+880)] x 13% = 8.45%

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