# Zagrot Trucking’s balance sheet shows a total of noncallable \$45 million long-term debt with a coupon rate of 8.00% and a yield to maturity of 6.00%. This debt currently has a market value of \$100 mil…

Zagrot Trucking’s balance sheet shows a total of noncallable \$45
million long-term debt with a coupon rate of 8.00% and a yield to
maturity of 6.00%. This debt currently has a market value of \$100
million. The balance sheet also shows that the company has 20
million shares of common stock, and the book value of the common
equity (common stock plus retained earnings) is \$650 million. The
current stock price is \$100 per share; stockholders' required
return, rs, is 13.00%; and the firm's tax rate is 21%.
The CFO thinks the WACC should be based on market value weights,
but the president thinks book weights are more appropriate. What is
the difference between these two WACCs?

## Solutions

##### Expert Solution

MV WACC

 MV of equity=Price of equity*number of shares outstanding MV of equity=100*20000000 =2000000000 MV of Bond=Par value*bonds outstanding*%age of par MV of Bond=1000*45000*2.22222222222222 =100000000 MV of firm = MV of Equity + MV of Bond =2000000000+100000000 =2100000000 Weight of equity = MV of Equity/MV of firm Weight of equity = 2000000000/2100000000 W(E)=0.9524 Weight of debt = MV of Bond/MV of firm Weight of debt = 100000000/2100000000 W(D)=0.0476 After tax cost of debt = cost of debt*(1-tax rate) After tax cost of debt = 6*(1-0.21) = 4.74 WACC=after tax cost of debt*W(D)+cost of equity*W(E) WACC=4.74*0.0476+13*0.9524 WACC =12.61%

BV WACC

 BV of firm = BV of Equity + BV of Bond =650000000+45000000 =695000000 Weight of equity = MV of Equity/MV of firm Weight of equity = 650000000/695000000 W(E)=0.9353 Weight of debt = MV of Bond/MV of firm Weight of debt = 45000000/695000000 W(D)=0.0647 After tax cost of debt = cost of debt*(1-tax rate) After tax cost of debt = 6*(1-0.21) = 4.74 WACC=after tax cost of debt*W(D)+cost of equity*W(E) WACC=4.74*0.0647+13*0.9353 WACC =12.47%

Difference: 12.61-12.47=0.14%