Module II· WACC & Capital StructureIntermediate
Question
How do you calculate WACC for a high-yield issuer (B rating or worse)?
Answer
Mechanics
The cost of debt for HY is high — typically 7–10% pretax at a B rating, 10%+ at CCC. After tax, the tax-shield benefit remains as long as the company is profitable.
Example (after-tax cost of debt)
Inputs:
- Pretax cost of debt: 7%
- Tax rate t: 30%
Calculation:
```
After-tax cost of debt = 7% × (1 − 30%) = 7% × 0.7 = 4.9%
```
CoE is also higher: a higher beta due to distress risk, often a +2% distress premium. WACC for an HY issuer is typically 9–12% — so not dramatically lower than pure equity financing.
Complication
For distressed targets (yield-to-maturity > 12%), the 'cost of debt' is really the cost of distressed equity — the Modigliani-Miller setup breaks down.
Practical approach
At very high leverage and distress risk, replace WACC with the APV method (adjusted present value): a standalone valuation plus a separate tax-shield value.