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    Computing The Weighted Average Cost of Capital

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    You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the CFO. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. The balance sheet and some other information about CGT follow below.

    Current assets $ 38,000,000
    Net plant, property, and equipment 101,000,000
    Total assets $139,000,000

    Liabilities and equity
    Accounts payable $ 10,000,000
    Accruals 9,000,000
    Current liabilities $ 19,000,000
    Long term debt (40,000 bonds, $1,000 par value) 40,000,000
    Total liabilities 59,000,000
    Common stock (10,000,000 shares) 30,000,000
    Retained earnings 50,000,000
    Total shareholders equity 80,000,000
    Total liabilities and shareholders equity $139,000,000

    You check The Wall Street Journal and see that CGT stock is currently selling for $7.50 per share and that CGT bonds are selling for $875.00 per bond. The bonds have a S1,000 par value, a 7.25% annual coupon rate, semiannual payments, are not callable, and a 20-year maturity. CGT's beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The expected return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. CGT is in the 40% tax bracket.

    What is the best estimate of the after-tax cost of debt for CGT?

    Using the CAPM approach, what is the best estimate of the cost of equity for CGT?

    Which of the following is the best estimate for the weights to be used when calculating the WACC?

    What is the best estimate of the WACC for CGT?

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    Solution Preview

    Please see the attached Excel 97-2003 file. Note that the bond is selling ...

    Solution Summary

    Given a bond selling at a discount, this comprehensive solution illustrates how to compute the company's weighted-average cost of capital.