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The East End Food Shop is estimating its WACC
The East End Food Shop is estimating its WACC. The company has collected the following information: Its capital structure consists of 40 percent debt and 60 percent common equity. The company has 20-year bonds outstanding with a 11 percent annual coupon that are trading at par. The company's tax rate is 40 percent. The risk-free rate is 4.5 percent The market risk premium is 7 percent. The stock's beta is 1.2. What is the company's WACC? TO RECEIVE CREDIT FOR THIS QUESTION YOU MUST SHOW BOTH YOUR ANSWER, ROUNDED TO TWO DECIMAL PLACES, AND THE CALCULATIONS USED TO ARRIVE AT THAT ANSWER. COMPUTATIONS FOR IRR, NPV AND OTHER TIME VALUE OF MONEY PROBLEMS MUST BE SOLVED WITH YOUR REQUIRED COURSE CALCULATOR, IF REQUESTED YOU MUST BE ABLE TO DEMONSTRATE THAT YOU USED THE REQUIRED COURSE CALCULATOR TO SOLVE THESE TYPE OF PROBLEMS
Expert Solution
| Weight of equity = 1-D/A |
| Weight of equity = 1-0.4 |
| W(E)=0.6 |
| Weight of debt = D/A |
| Weight of debt = 0.4 |
| W(D)=0.4 |
| Cost of equity |
| As per CAPM |
| Cost of equity = risk-free rate + beta * (Market risk premium) |
| Cost of equity% = 4.5 + 1.2 * (7) |
| Cost of equity% = 12.9 |
| After tax cost of debt = cost of debt*(1-tax rate) |
| After tax cost of debt = 11*(1-0.4) |
| = 6.6 |
| WACC=after tax cost of debt*W(D)+cost of equity*W(E) |
| WACC=6.6*0.4+12.9*0.6 |
| WACC =10.38% |
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