ABC Trucking\'s balance sheet shows a total of noncallable $38 million long-term
ID: 2738740 • Letter: A
Question
ABC Trucking's balance sheet shows a total of noncallable $38 million long-term debt with a coupon rate of 7.10% and a yield to maturity of 6.80%. This debt currently has a market value of $54 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity is $185.50 million. The current stock price is $21.05 per share; stockholders' required return, rs, is 17.55%; and the firm's tax rate is 30.00%. 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? Work with at least 4 decimals and round your final answer to two decimal places. For example, if your answer is $345.6671 round as 345.67 and if your answer is .05718 or 5.7182% round as 5.72.
Available answers: –0.41%, –0.52%, –0.55%, –0.44%, –0.38%
Explanation / Answer
The weighted average cost of capital can be calculated with the use of following formula:
WACC = Weight of Debt*After-Tax Cost of Debt + Weight of Equity*Cost of Equity
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Book Value
Weight of Debt = Book Value of Debt/(Book Value of Debt + Book Value of Equity) = 38/(38 + 185.50)
Weight of Equity = Book Value of Equity/(Book Value of Debt + Book Value of Equity) = 185.50/(38 + 185.50)
WACC = 38/(38+185.50)*6.80%*(1-30%) + 185.50/(38+185.50)*17.55% = .1538
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Market Value
Market Value of Equity = Number of Common Shares Outstanding*Stock Price Per Share = 10*21.05 = $210.50
Weight of Debt = Maket Value of Debt/(Market Value of Debt + Market Value of Equity) = 54/(54 + 210.50)
Weight of Equity = Maket Value of Equity/(Market Value of Debt + Market Value of Equity) = 210.50/(54 + 210.50)
WACC = 54/(54 + 210.50)*6.80%*(1-30%) + 210.50/(54 + 210.50)*17.55% = .1493
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Difference in Market Value = Market Value - Book Value = .1493 - .1538 = -0.004366 or -0.44
Answer is -.44% (which is Option D)