Sanford Company currently has 15% of its market value in debt and 85% in common stock, with no preferred stock. Its debt has a coupon rate of 7%, a yield-to-maturity of 6%, and a corporate tax rate of 35%. The expected market return is 11% and the risk-free rate is 3%. Sanford has a Beta of 0.90.

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Business

Abraham Rich

2 November, 02:16

Sanford Company currently has 15% of its market value in debt and 85% in common stock, with no preferred stock. Its debt has a coupon rate of 7%, a yield-to-maturity of 6%, and a corporate tax rate of 35%. The expected market return is 11% and the risk-free rate is 3%. Sanford has a Beta of 0.90.

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Alena Kerr · Answer 1

WACC is 9.35%

Explanation:

In order for us to compute the weighted average cost of capital, we have to first find the cost of equity (Ke) and the cost of debt (Kd)

1. Ke can be found by using CAPM - Capital Asset Pricing Model.

CAPM Formula: Ke = Rf + b (Rm-Rf)

where Rf = Risk free rate; Rm = Return expected of the market; b = beta

Therefore = Ke = 3% + 0.9 (11%-3%) = 10.2%

2. Kd = Coupon rate (1 - tax rate), coupon rate is 7%, tax rate is 35%

therefore Kd = 7 (1-0.35) = 4.35%

Lastly we apply the WACC Formula which is Ke * (equity value/Total value of equity and debt) + kd * (debt value/Total value of equity and debt)

We are not given the values of equity and debt, bur we are given the fractions; we will use the fractions.

Therefore: Ke * (equity value/Total value of equity and debt) + kd * (debt value/Total value of equity and debt) = (10.2%*85%) + (4.35%*15%) = 9.35%