JAK Industries has 5 million shares of stock outstanding selling at $25 per share and an issue of $40 million in 8 percent, annual coupon bonds with a maturity of 15 years, selling at 108 percent of par ($1000). If JAK's weighted average tax rate is 34 percent and its cost of equity is 15 percent, what is JAK's WACC

12.42 %

Explanation:

Weighted Average Cost of Capital (WACC) is the return that is required by providers of Long term sources of finance.

WACC = Ke x (E/V)) + Kd x (D/V)

Where,

Ke = Cost of Equity

     = 15 %

Kd = After tax Cost of Debt

Calculation :

Pv = - $1080

N = 15

P/yr = 1

Pmt = $1000 × 8% = $80

FV = $1000

i = ?

Using a financial calculator, the pretax cost of debt is 7.11 %

Therefore,

After tax Cost of Debt = 7.11 % × (1 - 0.34)

                                    = 4.96 %

E/V = Market Weight of Equity

      = (5,000,000 × $25 ) ÷ ( 5,000,000 × $25 + 40,000 × $1080)

      = 0.7432

D/V = Market Weight of Debt

      = (40,000 × $1080) ÷ ( 5,000,000 × $25 + 40,000 × $1080)

      = 0.2568

Therefore,

WACC = 15 % × 0.7432 + 4.96 % × 0.2568

           = 12.42 %

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