Question

Easy Car Corp. is a grocery store located in the Southwest. It paid an annual dividend of $10.00 last year to its shareholders and plans to increase the dividend annually at the rate of 4.0% forever. It currently has 600,000 common shares outstanding. The shares currently sell for $50 each. Easy Car Corp. also has 20,000 semiannual bonds outstanding with a coupon rate of 8.9141%, a maturity of 26 years, and a par value of $1,000. The bonds currently have a yield to maturity (YTM) of 10%. The corporate tax rate is 25 %? Use 4 decimals in all your calculations (round final answers to two decimals). 1. What is the cost of debt for Easy Corp.? Enter using the %, for example if you obtain 0.20 then enter 20% 2. How many interest payments are left for the bond of Easy Corp.? A 3. What is the interest payment per period for the bond? Do not enter dollar sign. Round to two decimals A 4. What is the discount rate per period to use in pricing the bonds? Enter using the %, for example if you obtain 0.105 then enter 10.50% A 5. What is the market value of equity for the calculation of the WACC for Easy? Do not enter dollar sign. Round to the nearest dollar (no decimals). Use comma to separate thousands. A 6. What is the cost of equity for Easy? Enter using the % and TWO decimal places for example if you obtain 4. 20% then

Answer 1

1. Cost of debt = coupon rate * (1- tax rate) = 0.089141 * (1 - 0.25) = 0.066856 = 6.6856%

2. Maturity of bond = 26 years
since bonds are semi annual, interests are paid twice in a year,
so, number of interest payments left for bond for Easy corp = 26 * 2 = 52

3. Number of bonds = 20,000
par value of bond = $1,000
Coupon rate = 8.9141 %
Annual paymnet for a bond = $1,000 * 8.9141 % = $89.141
Since bonds are semi annual payments,
so, interest payment per period = ($89.141 / 2) * 20,000 = $891,410

4. Yield to maturity = 10%
yield per period = 10%/2 = 5%
Number of period = 26*2 = 52
Present value of principal = $1,000/(1.05 ^ 52) = $79.1
Coupon rate = 8.9141%
coupon rate per period = 8.9141%/2 = 4.45755%
Coupons received per period = $1,000 * 4.45755% = $44.5755
Present value of all coupons received = $44.5755/(1.05^1) + $44.5755/(1.05^2)+ ---- + $44.5755/(1.05^52)
= $44.5755 *[1-(1/(1.05^52)]/0.05 = $820.9948
Market price of bond = $820.9948 + $79.1 = $900.09
Discount = $1000 - $900.09 = $99.91
Discount rate = $99.91/$1000 = 0.09991=9.99%

5. Market value of equity = current market price * total numebr of shares
= $50 * 600,000 = $30,000,000

6. Dividen paid last year = $10
Market price of share = $50
Growth rate of dividend = 4%
Cost of equity = (Dividend per share for next year/ market price per share) * growth rate of dividend
= ($10.40 / $50) * 0.04 = 0.00832 = 0.83%