Question 1

A company has the following capital structure:
- Debt: $4,000,000 par value bonds, 6% coupon, currently trading at 102. Flotation costs are negligible.
- Equity: 500,000 shares outstanding, current price $25 per share. Beta is 1.2.
- Risk-free rate is 3%; Market risk premium is 5%.
- Corporate tax rate is 25%.

What is the company's Weighted Average Cost of Capital (WACC)?

Accepted Answer

1. Calculate Market Value of Debt and Equity. 2. Calculate Weights. 3. Calculate Cost of Equity (CAPM). 4. Calculate After-tax Cost of Debt (Effective rate * (1-Tax)). 5. WACC = We*Re + Wd*Rd.

Question 2

What mistakes do candidates make on this CPA question?

Accepted Answer

Using book values; forgetting tax shield on debt; using coupon rate directly without tax adjustment.

How to approach this question

Full Answer

Common mistakes

Practice the full CPA BAR Practice Exam 3

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