Series 79 weighted avg CC

Question

1. You are trying to estimate the value of the stock of Aero Inc. by LIMITED Co. and gather the following information: 

FCFF at the end of 2020	$800 million
Before-tax cost of debt	2.5%
Required rate of return on equity	12%
Target debt-to-equity ratio	.3
Number of common shares outstanding	500 million
Expected long-term growth rate in FCFF	4%
Tax rate	18%
Book value of debt	$1.3 billion
Market value of debt	$1.5 billion

What is the weighted average cost of capital? 

A. 9.70%

B. 6.53%

C. 9.38%

D. 6.57%

Answer 1

Weighted Average Cost of Capital=(mkt value of equity/(mkt value of equity+debt)*required ROR on equity)*(mkt value of debt/(mkt value of debt+equity)*Before-tax cost of debt*(1-tax rate))

Since target debt-to-equity ratio is 0.3 that means 1.5 billion/equity=0.3 so rearranging it equity=1.5 billion/0.3=5 billion

now plugging it all in

WACC=5/6.5*.12*1.5/6.5*.025*(1-.18)

=9.7%-Answer A