ABC Trucking\'s balance sheet shows a total of noncallable $31 million long-term
ID: 2620875 • Letter: A
Question
ABC Trucking's balance sheet shows a total of noncallable $31 million long-term debt with a coupon rate of 6.80% and a yield to maturity of 6.60%. This debt currently has a market value of $53 million. The balance sheet also shows that the company has 9 million shares of common stock, and the book value of the common equity is $173.90 million. The current stock price is $22.10 per share; stockholders' required return, rs, is 11.75%; and the firm's tax rate is 37.00%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between the WACCs using market value and the book value?
Explanation / Answer
WACC = Cost of equity*[E/E+D]+Cost of Debt*[D/D+E]*(1-Tax rate)
Case 1: Book Value
WACC = 11.75%*[$173,90/($173.90+31]+6.6%*[$31/($31+$173.90]*(1-0.37)
WACC = 10.60%
Case 2 : Market Value
Market value of equity = $22.10*9million = $198.9 million
WACC = 11.75%*[$198.9/($198.9+53]+6.6%*[$53/($53+$198.90]*(1-0.37)
WACC = 10.15%
Difference = 10.60%-10.15% = 0.45%