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JimMart: Weighted Average Cost of Capital (WACC)

A stock analyst has obtained the following information about JimMart, a large retail chain.

(1) The company has non-callable bonds with 20 years maturity remaining and a maturity value of $1000. The bonds have a 12 percent annual coupon and currently sell at a price of $1273.8564.

(2) Over the past four years, the returns on the market and on JimMart were as follows:

Year Market JimMart
2003 12.0% 14.5%
2004 17.2% 22.2%
2005 -3.8% -7.5%
2006 20.0% 24.0%

(3) The current risk-free rate is 6.35 percent, and the expected return on the market is 11.35 percent. The company's tax rate is 35 percent.

The company anticipates that its proposed investment projects will be financed with 70 percent debt and 30 percent equity. What is the company's estimated weighted average cost of capital (WACC)?

How does this process compare/differ from finding the cost of funds at a commercial bank? What are the potential difficulties involved in the use of book versus market values particularly as it applies to a financial institution?

Solution Preview

Cost of Debt 12%

Year Market JimMart
2003 12% 14.50%
2004 17.20% 22.20%
2005 -3.80% -7.50%
2006 20% 24%

Beta 1.02

Risk-free rate 6.35%
Expected return of ...

Solution Summary

The weighted average cost of capital is calculated. Potential difficulties a financial institution could face are explained as well.