##### Question

# 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, r_{s}, 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%

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