Skolits Corporation has a cost of equity of 11.1% and an aftertax cost of debt of 4.23%. The company's…

Question

Skolits Corporation has a cost of equity of 11.1% and an aftertax cost of debt of 4.23%. The company's balance sheet lists long-term debt of 305,000 and equity of 565,000. The company's bonds sell for 95.3% of par and the market-to-book ratio is 2.5 times. If the company's tax rate is 22%, what is the WACC?

ScanSolve AI Tutor · Accepted Answer

To calculate the Weighted Average Cost of Capital (WACC), we need to determine the weights of equity and debt in the capital structure and then apply the respective costs.

Calculate the market value of debt (D)
$\text{Market Value of Debt} = \text{Long-term Debt} \times \text{Price of Bonds} = 305,000 \times 0.953 = 290,615$
Calculate the market value of equity (E)
$\text{Market Value of Equity} = \text{Equity} \times \text{Market-to-Book Ratio} = 565,000 \times 2.5 = 1,412,500$
Calculate total market value (V)
$V = E + D = 1,412,500 + 290,615 = 1,703,115$
Calculate weights
$w_e = \frac{E}{V} = \frac{1,412,500}{1,703,115} \approx 0.829$ $w_d = \frac{D}{V} = \frac{290,615}{1,703,115} \approx 0.171$
WACC formula
$\text{WACC} = w_e \cdot r_e + w_d \cdot r_d \cdot (1 - \text{Tax Rate})$
Where:
- $r_e = 11.1\%$
- $r_d = 4.23\%$
- Tax Rate = 22%
Calculate WACC
$\text{WACC} = 0.829 \cdot 0.111 + 0.171 \cdot 0.0423 \cdot (1 - 0.22)$ $\text{WACC} = 0.092079 + 0.171 \cdot 0.0423 \cdot 0.78$ $\text{WACC} = 0.092079 + 0.005515 \approx 0.097594$
Thus, the WACC is approximately 9.76%.

Step-by-step solution

Calculate the market value of debt (D)

Calculate the market value of equity (E)

Calculate total market value (V)

Calculate weights

WACC formula

Calculate WACC

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