Carbon Fiber Design and Build Inc. is considering the purchase of new

Carbon Fiber Design and Build Inc. is considering the purchase of new a new carbon molding machine for use in their Sports Operations department. The investment would be an expansion of an industry segment that the firm knows well.

You have been tasked with helping the division manager determine the WACC in advance of an analysis of the expected cash flows for the project. You have collected the following information: The firm has no preferred stock outstanding and plans to issue new preferred stock. The estimated tax rate for the firm is 30%. The firm currently has 500 10-year $1,000 face value bonds outstanding with 7% semi-annual coupons that are selling for $1,036.35. The firm also has 31,888 shares of common stock outstanding at a price of $32.50 per share. You estimate that the market risk premium is 6%, the current yield to maturity on 10-year Treasury bonds is 3%, and the firm’s beta is 0.95. Given this information, calculate the after-tax cost of debt, the cost of equity, and the firm’s WACC.

ANSWER

Cost of debt via calculator: N = 20, PV = -$1,036.35, PMT = $35, FV = $1,000, solve for the rate = 3.25% x2 = annual rate of 6.50%
after-tax cost of debt = 6.5% * (1-.3 ) = 4.55%
Cost of equity via CAPM = 3% + 0.95 * 6% = 8.70%
Value of debt = 500 * $1,036.35 = $518,175
Value of equity = $32.50 * 31,888 = $1,036,360
Weight of debt = $518,175/$1,554,535 = .333
Weight of equity = $1,036,360/$1,554,535 = .667
WACC = .333 * 4.55% + .667 * 8.70% = 7.32%