Easy Car Corp. is a grocery store located in the Southwest. It paid an annual dividend of $2.00 last year to its shareholders and plans to increase the dividend annually at the rate of 4.0%. It currently has 2,000,000 common shares outstanding. The shares currently sell for $13 each. Easy Car Corp. also has 30,000 semiannual bonds outstanding with a coupon rate of 10%, a maturity of 23 years, and a par value of $1,000. The bonds currently have a yield to maturity (YTM) of 8%. What is the weighted average cost of capital (WACC) for Easy Car Corp. if the corporate tax rate is 30%? When answering this problem enter your answer using percentage notation but do not use the % symbol and use two decimals (rounding). For example, if your answer is 0.10469 then enter 10.47; if your answer is 10% then enter 10.00

Since the instruction in the question indicates that the % symbol should not be used, the weighted average cost of capital (WACC) for Easy Car Corp is therefore 12.07.

Step-by-step explanation:

This can be calculated using the following steps:

Step 1: Calculation of the current bond price

Semiannual coupon amount = Bond face value * Semiannual coupon rate = $1000 * (10% / 2) = $50

Semiannual coupon discount factor = ((1 - (1 / (1 + r))^n) / r) (1)

Where;

r = Semiannual yield to maturity (YTM) = 8% / 2 = 0.08 / 2 = 0.04

n = number of semiannuals = 23 years * 2 = 46

Substituting the values into equation (1), we have:

Semiannual coupon discount factor = ((1-(1/(1 + 0.04))^46) / 0.04) = 20.8846535613106

Present value of coupon = (Semiannual coupon amount * Semiannual coupon discount factor) = $50 * 20.8846535613106 = $1,044.23

Present value of the face value of the bond = Face value / (1 + r)^n = $1,000 / (1 + 0.04)^46 = $164.61

Therefore, we have:

Current bond price = Present value coupon + Present value of the face value of the bond = $1,044.23 + $164.61 = $1,208.84

Step 2: Calculation of weights of each finance source

Market value of common shares outstanding = Number common shares outstanding * Current price per share = 2,000,000 * $13 = $26,000,000.

Market value of bond = Number of bonds * Current bond price = 30,000 * $1,208.84 = $36,265,200

Total financing market value = Market value of common shares outstanding + Market value of bond = $26,000,000 + $36,265,200 = $62,265,200

Weight of Market value of common shares outstanding = Market value of common shares outstanding / Total financing market value = $26,000,000 / $62,265,200 = 0.42

Weight of Market value of bond = Market value of bond / Total financing market value = $36,265,200 / $62,265,200 = 0.58

Step 3: Calculation of return on equity

Current year dividend = Last year dividend * (1 + Dividend growth rate) = $2 * (1 + 4.0%) = $2.08

Next year dividend = Current year dividend * (1 + Dividend growth rate) = $2.08 * (1 + 4.0%) = $2.1632

The return on equity can now be calculated using the following formula:

Current share price = Next year dividend / (Return on equity – Dividend growth rate) ………………….. (2)

Where;

Current share price = $13

Next year dividend = $2.1632

Return on equity = ?

Dividend growth rate = 4.0%, or 0.04

Substituting the values into equation (2) and solve for return on equity, we have:

13 = 2.1632 / (Return on equity - 0.04)

13 * (Return on equity - 0.04) = 2.1632

(13 * Return on equity) – (13 * 0.04) = 2.1632

(13 * Return on equity) – 0.52 = 2.1632

13 * Return on equity = 2.1632 + 0.52

Return on equity = 2.6832 / 13

Return on equity = 0.21

Step 4: Calculation of Weighted average cost of capital

Weighted average cost of capital = (WS * CE) + (WD * CD * (1 – T)) ………………… (4)

Where;

WS = Weight of Market value of common shares outstanding = 0.42

WD = Weight of debt = Weight of Market value of bond = 0.58

CE = Cost of equity = Return on equity = 0.21

CD = Cost of debt = YTM = 8%, or 0.08

T = Tax rate = 30%, or 0.30

Substituting the values into equation (3), we have:

Weighted average cost of capital = (0.42 * 0.21) + (0.58 * 0.08 * (1 - 0.30)) = 0.12068, or 12.068%

Rounding to two decimal places, we have:

Weighted average cost of capital = 12.07%

Since the instruction in the question indicates that the % symbol should not be used, the weighted average cost of capital (WACC) for Easy Car Corp is therefore 12.07.

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