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Homework answers / question archive / The table shows a book balance sheet for the Wishing Well Motel chain
The table shows a book balance sheet for the Wishing Well Motel chain. The company’s long-term debt is secured by its real estate assets, but it also uses short-term bank financing. It pays 10% interest on the bank debt, which is permanent financing and 9% interest on the secured debt. Wishing Well has 10 million shares of stock outstanding, trading at $90 per share. The expected return on Wishing Well’s common stock is 18%
Calculate Wishing Well’s WACC. Assume that the book and market value of Wishing Well’s debt are the same. The marginal tax rate is 35%.
Please show your work.
| Cash & Market securities | 100 | Bank loan | 280 |
| Accounts receivable | 200 | ||
| Inventory | 50 | Accounts payable | 120 |
| Current assets | 350 | Current Liabilities | 400 |
| Real estate | 2100 | Longterm debt | 1800 |
| Other assets | 150 | Equity | 400 |
| Total | 2600 | Total | 2600 |
Solution: Calculation of WACC
WACC=cost of common stock*weight of common stock+interest on bank debt(1-tax rate)*weight of bank debt+interest on secured debt(1-tax rate)*weight of secured debt
First we need to calculate the weight of each source of financing as follow:
Total market value=Market value of common share+market value of bank debt+Market value of secured debt
=(10million*$90)+$280+$1800 million
=$900million+$280million+1800million
=$2980 million
Weight of common shares=Market value of common share/Total market value
=$900 million/$2980 million
=0.302
Weight of bank debt=$280 million/$2980 million
=0.094
Weight of secured debt=$1800 million/$2980 million
=0.604
WACC=18%*0.302+10%(1-0.35)*0.094+9%*(1-0.35)*0.604
=5.436+0.611%+3.533%
=9.58%
