Corporate finance module 8: Weighted average cost of capital (WACC)

A firm has the following capital structure:

Long-term debt: par value     953,000
Long-term debt: market value     926,414
Coupon rate    7.00%
Yield to maturity     7.29%
Shares of common stock     14,100
Par value per share    65
Market value per share    64
Expected return on common stock of firm    10.10%
Tax rate     30%


Interest on corporate debt is deductible from taxable income.

A.    What is the value of the firm’s debt?
B.    What is the value of the firm’s equity?
C.    What is the value of the firm?
D.    What is the firm’s debt to value ratio?
E.    What is the firm’s equity to value ratio?
F.    What is the firm’s cost of debt capital?
G.    What is the firm’s cost of equity capital?
H.    What is the firm’s after-tax weighted average cost of capital (WACC)?

Part A: The market value of the firm’s debt is 926,414.

Part B: The market value of the firm’s equity is 14,100 × 64 = 902,400.

Part C: The total market value of the firm is 926,414 + 902,400 = 1,828,814.

Part D: The firm’s debt to value ratio is 926,414 / 1,828,814 = 50.66%.

Part E: The firm’s equity to value ratio is 902,400 / 1,828,814 = 49.34%.

Part F: The firm’s cost of debt capital is the yield to maturity of 7.29%.

Part G: The firm’s cost of equity capital is the expected return on common stock of 10.10%.

Part H: The firm’s after-tax weighted average cost of capital (WACC) =

WACC = rD (1 – Tc) (D/V) + rE (E/V) or

Weighted average cost of capital    = return on debt capital
                                    × (1 – corporate tax rate)
                                    × debt to value ratio
                                    + return on equity capital
                                    × equity to value ratio

= 7.29% × (1 – 30%) × 50.66% + 10.10% × 49.34% = 7.57%.