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8 February, 15:26

Sapp Trucking's balance sheet shows a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%. This debt currently has a market value of $50 million. The balance sheet also shows that the company has 10 million shares of common stock, and the book value of the common equity (common stock plus retained earnings) is $65 million. The current stock price is $22.50 per share; stockholders' required return, rs, is 14.00%; and the firm's tax rate is 40%. 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?

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  1. 8 February, 16:23
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    The difference between two WACC is 1.2%.

    Explanation:

    As we know that

    WACC = Ke * Ve / (Ve + Vd (1-Tax)) + Kd * Vd * (1-tax) / (Ve + Vd * (1-Tax))

    Using the Book Value Method:

    WACC = 14% * $65 / ($65m + $45m (1-40%))

    + 6% * $45m * (1-.4) / ($65m + $45m (1-40%))

    WACC = 10% + 1.8% = 11.8%

    Using the market value method:

    Market Value of Common Stock = Common Shares * Market value per share

    Market Value of Common Stock = 10 million * $22.5 per share = $225m

    WACC = 14% * $225 / ($225m + $50m (1-40%))

    + 6% * $50m * (1-.4) / ($225m + $50m (1-40%))

    WACC = 12.35% + 0.7% = 13%

    The difference between two WACC is 1.2%.
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