Practice Question
Nike has $100M face value of outstanding debt with a coupon of 10% and a yield to maturity of 8% (annualized). The bond makes semi-annual payments and has 10 years to maturity. The company has 1 million shares of common stock with book value per share of $35 and market value per share of $50. The current beta of the stock is 1.5. The treasury bill rate is 5% and the market risk premium is 8.5%. The company is in the 40% tax bracket. What is the company’s WACC?
Step 1: Calculate the after-tax cost of debt (Rd)
YTM = 8%, Tax Rate = 40%
Rd = 8% × (1 − 0.40) = 4.8%
Step 2: Calculate the cost of equity (Re) using CAPM
Re = Rf + β × (Rm − Rf) = 5% + 1.5 × 8.5% = 17.75%
Step 3: Calculate the weights of debt and equity
Market Value of Equity = 1M × $50 = $50M
Market Value of Debt = $100M
Total Value (V) = $150M
Weight of Debt (Wd) = 100 / 150 = 0.6667
Weight of Equity (We) = 50 / 150 = 0.3333
Step 4: Compute WACC
WACC = (Wd × Rd) + (We × Re)
WACC = (0.6667 × 4.8%) + (0.3333 × 17.75%)
WACC ≈ 3.20% + 5.92% = 9.12% (approximate)
Acceptable answer due to rounding: 8.82%