Question

2. Use the bulleted information below to find: a. Cost of debt b. Cost of equity (use CAPM) c. The current stock price (use DGM) d. Total market value of equity e. Total market value of deht f. WACC • The firm has 30 million shares of common stock outstanding. The beta is 2. The firm most recently paid a $5.50 dividend and plans to increase dividends by 2% per year indefinitely The expected return on the market portfolio is 12% and the risk-free rate is 4%. The firm has one bond issue outstanding. All bonds make annual coupon payments and are 5% coupon bonds with face value of $1000. They are currently trading at face value. There are 100,000 of these bonds. The firm's average tax rate is 30%. •

Answer 1

Cost of debt= Interest rate(1-tax rate)

= 5*0.70 = 3.50%(Answer a)

Cost of equity(using CAPM)= Risk free rate+ Beta(Market premium)

= 4+ 2(12-4) =20% (Answer b)

Stock price(Applying Gordon growth) = Dividend to be paid/(cCost of equity-growth rate)

= 5.5*1.02/(0.2-0.02) = 5.61/0.18= $31.17(Answer c)

Market value of equity= price*No. of shares= 31.17*30000000= $935000000( Answer d)

Market value of bonds= No. of bonds* price= 10000*1000= $10000000( Answer e)

WACC= 3.50*(10000000/945000000)+ 20*(935000000/945000000)

=0.037+ 19.788

= 19.825%( Answer f)