Reference no: EM13988502

Weighted Average Cost of Capital Exercise

You wish to value ABC Corp and need to calculate its weighted average cost of capital (WACC).  You get the most recent 10-K filing and dig into the footnotes to uncover the following items related to ABC's debt.  You look up the current price of each of ABC's bond using Bloomberg to reveal:

Long-term debt

Long-term debt
Tenor (yr)	Coupon	Principal ($mil)	Price
3	6.00%	150	101.56
5	6.25%	400	102.34
7	8.00%	250	114.36

Exercise 1. 

• Using the information above, calculate the yield to maturity on each of ABC's bonds assuming semi-annual pricing convention. 
• Calculate the total amount of long-term debt outstanding by summing the principal on the three bonds.
• Determine the weighted average yield to maturity on ABC's long-term debt by taking the weight of each bond times its yield (calculated in part A above) and then summing these yields across the three bonds.

Long-term debt
amount	average yield
$800.00	5.47%

Short-term debt

ABC Corp has a $250 million revolving line of credit that is used for working capital needs and general corporate purposes and is considered permanent capital.  Currently there is $50 million drawn and this carries an interest rate of Libor + 200 basis points.  Assume Libor is 0.50% now.

Exercise 2.

Treat the revolving line of credit as short-term debt and determine the amount and the cost of this funding.

Short-term debt
amount	average yield
$50.00	2.50%

Equity

In 2005, ABC issued 10 million shares at $20 per share and these shares are still outstanding.  The current stock price is $145.67 with a risk-free rate of 4%, market risk premium of 6%, and beta of 1.25.

Equity amount cost $1,456.70 11.50%

All together now...

WACC = w_dk_d(1-T)+w_stdk_std(1-T)+w_ek_e

Assume a corporate tax rate of 35%

Calculate the total capitalization by adding the amounts from long-term debt, short-term debt, and equity.  Determine the weights of each by dividing the individual amount by the total capitalization.

wd	kd	(1-T)	wstd	kstd	(1-T)	we	ke

WACC = _____________