Question

The Paulson Company's year-end balance sheet is shown below. Its cost of common equity is 18%, its before-tax cost of debt is 8%, and its marginal tax rate is 25%. Assume that the firm's long-term debt sells at par value. The firm's total debt, which is the sum of the company's short-term debt and long-term detit, equals $1,158. The firm has 576 shares of common stock outstanding that sell for $4.00 per share. Assets Liabilities And Equity Cash $ 120 Accounts payable and accruals $ 10 Accounts receivable 240 Short-term debt 58 Inventories 360 Long-term debt 1,100 Plant and equipment, net 2,160 Common equity 1.712 Total assets $2,880 Total liabilities and equity $2,880 Calculate Paulson's WACC using market value weights. Do not round intermediate calculations. Round your answer to two decimal places %

Answer 1

To calculate Paulson Company's WACC, the market values of equity and debt are used along with their respective costs, considering the tax effects on debt cost. Equity market value is computed using share quantity and price, and WACC combines the weighted costs of both equity and debt components.

Step-by-step explanation:

Calculating Paulson's WACC

To calculate the Weighted Average Cost of Capital (WACC) for Paulson Company, we need to use the market value weights for each component of the capital structure – equity and debt – and apply the cost of each. The market value of equity can be found by multiplying the number of outstanding shares by the market price per share. The total debt is already given and assumed to be equal to its par value.

Here's how you can calculate the components required for WACC:

• The market value of equity (E) = Number of shares × Market price per share = 576 shares × $4.00 = $2,304.
• After-tax cost of debt (Rd) = Before-tax cost of debt × (1 - Tax rate) = 8% × (1 - 0.25) = 6%.
• The weights of equity (We) and debt (Wd) would be calculated as the proportion of each in the total market value of the firm's financing. Therefore, We = Market value of equity / (Market value of equity + Total debt) and Wd = Total debt / (Market value of equity + Total debt).

Once we have the market value-based weights and costs, we can calculate the WACC:

WACC = (We × Re) + (Wd × Rd)

Where Re is the cost of equity and Rd is the after-tax cost of debt.