Tim works for WatermanCorp, a manufacturer of high-pressure industrial water pum
ID: 2807278 • Letter: T
Question
Tim works for WatermanCorp, a manufacturer of high-pressure industrial water pumps. He reports directly to the CFO and she has asked him to calculate WatermanCorp's WACC. He has gathered the following information about WatermanCorp: its market capitalization (its market value of equity) is $140 million, its beta is 1.4, the total book value of its debt is $50 million, it has $20 million cash, and its cost of debt (using the quoted yields on WatermanCorp's outstanding bond issues) is 4%. In addition, the yield of the 10-year government bond (the risk-free rate) is 2%, the market risk premium is 5%, and the marginal corporate tax rate is 35%. Calculate WatermanCorp's WACC. When is it appropriate to use this WACC to evaluate a new project? Calculate WatermanCorp's WACC Round to two decimal places.)Explanation / Answer
Value of Equity = $140 million
Value of Debt = $50 million
Total Value of Company = Value of Equity + Value of Debt
Total Value of Company = $140 million + $50 million
Total Value of Company = $190 million
Weight of Equity = $140 million / $190 million
Weight of Equity = 0.7368
Weight of Debt = $50 million / $190 million
Weight of Debt = 0.2632
Cost of Equity = Risk-free Rate + beta * Market Risk Premium
Cost of Equity = 2% + 1.4 * 5%
Cost of Equity = 9.00%
Before-tax Cost of Debt = 4%
After-tax Cost of Debt = 4%*(1-0.35)
After-tax Cost of Debt = 2.60%
WACC = Weight of Debt*After-tax Cost of Debt + Weight of Equity*Cost of Equity
WACC = 0.2632 * 2.60% + 0.7368 * 9.00%
WACC = 7.32%
So, WatermanCorp's WACC is 7.32%