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which rate we use to calculate WACC  

Question

Acme, Inc.

Balance Sheets as of 12/31/09 and 12/31/10

($ in thousands)

 

                              2007      2008                                                      2007        2008

Cash                     $ 2650    2810                 accounts payable          $ 1350     $ 1000

Accounts rec.         980        840                 long-term debt               3300        3300

Inventory               1560      1990                 common stock             3200        3500

Total                     $ 5190     5640              retained earnings            940         1200

Net fixed assets     3600       3360          

Total asset            $ 8790     $ 9000          total liabilities & equity $ 8790      $ 9000       

 

Notes to Financial Statements: The rate and amount of the Company’s total long-term, fixed rate debt outstanding for the Company in 2009 and 2010 remained unchanged. The 12/31/10 market rate on debt for companies with a similar risk profile and maturity as Acme’s was 12%. The market value of Acme’s long-term debt on 12/31/10 was $3 million. Acme’s market capitalization on 12/31/10 was $6 million. As of 12/31/10, the risk free rate was 3%, the expected market rate of return was 11%, and Acme’s beta was 1.50. Due to a large net-operating-loss-cany-forward and substantial tax credits, Acme paid no taxes in 2009 and 2010, and it is NOT expected that the Company will be paying any taxes in the next 5 years.

 

 

To calculate the Weighted Average Cost of Capital (WACC) for Acme as of 12/31/10 using your

previous answers and the assumptions given above in the “Notes to Financial Statements”, what

rate should we use for the cost of shareholders’ equity?

a. 9%

b. 10%

c. 11%

d. 15%

e. 16%

 

 

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