Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt wi

Question

Bolster Foods’ (BF) balance sheet shows a total of $25 million long-term debt with a coupon rate of 8.50%. The yield to maturity on this debt is 8.00%, and the debt has a total current market value of $27 million. The balance sheet also shows that the company has 10 million shares of stock, and the stock has a book value per share of $5.00. The current stock price is $20.00 per share, and stockholders' required rate of return, rs, is 12.00%. The company recently decided that its target capital structure should have 35% debt, with the balance being common equity. The tax rate is 40%. Calculate WACCs based on book, market, and target capital structures, and then find the sum of these three WACCs. a. 26.60% b. 36.27% c. 30.22% d. 27.81% e. 24.78%

Explanation / Answer

Solution:-

Ans:- c) 30.22%

Calculations:-

WACC= Cost of debt*(1-tax)*weight of debt+ Cost of equity*weight of debt

Cost of debt = 8.00%

Cost of equity= 12.00%

a)WACC based on book value

Book value of debt = $25 million

Book value of equity = 10million*$5.00/share = $50 million

Now,

    WACC= 8.00%*(1-0.40)*25/75+12%*50/75 =1.6%+8%=9.6%

b)WACC based on market value

Market value of debt = 27 million

Market value of equity = 10 million*$20/share =200 million

WACC= 8.00%*(1-0.40)*27/227+12%*200/227=0.5709%+10.57268%

           =11.14%

c) WACC based on target capital structure.

Weight of debt = 35%

Weight of equity= 65%

WACC= 8.00%*(1-0.40)*0.35+12%*0.65 =1.68%+7.8%=9.48%

Sum of all three WACC= 9.6%+11.14%+9.48%= 30.22%

Please feel free to ask if you have any query in the comment section.

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