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 %?

Answer 1

a. Market value of equity = current market price X number of shares outstanding.
= 50 x 600,000 = 30,000,000 (answer)

b. Cost of equity = 24.8% (answer)

c.No of periods (N) = 26 x 2 = 52
YTM for half year 10/2 = 5%
Coupon amount (semi annual )= 1000×8.9141%×(0.5) = 44.5705
Par value = 1000

The price of the bond = coupon amount x PVAF(YTM, N) + Par value× PVIF (YTM, N)

=44.5705x PVAF(5%, 36) + 1000× PVIF (5%, 36 )
= $449.61

The price of the bond = $449.61

(Note:
PVAF = present value annuity factor.
PVIF = present value interest factor.)

Market value of debt = number of bonds outstanding x current market price of Bond.
=20,000 x 449.61
=$8,992,200

d.Total market value= market value of equity+market value of debt.

=Number of shares outstanding x current share price+ the number of debt outstanding x current selling price.

= 38,992,200

Weight of equity= market value of equity/total market value.
= 0.769

Weight of debt = market value of debt/total market value.
= 0.231 (Answer)

d.
WACC = WEIGHTED AVERAGE COST OF CAPITAL.

It's the overall cost of raising funds for the firm.

The weighted average cost of capital= (weight of equity x cost of equity)+(weight of debt x cost of debt)

= (0.769 x24.8)+(0.231x 10)

WACC = 21.38% (answer)

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