Question

Question 2 Orange Corp has 1 million shares outstanding, and the stock is currently trading at $10 per share. The company has two different bonds outstanding. First, it has 5000 zero coupon bonds outstanding. Each zero coupon bond has a face value of $1000, will mature in 5 years, and is currently priced at 65% of face value. Second, the company has 5000 coupon paying bonds outstanding. Each coupon paying bond is currently priced at $940.00, and the YTM is 11%. You have decided to calculate the cost of equity using the SML equation. You have estimated that the risk-free rate is 5%, and the expected rate of return on the market portfolio is 10%. You also have estimated that the equity beta of the company is 2.5. Finally, the company faces a tax rate of 30%. Using the information given, calculate the cost of capital (WACC) of Orange Corp. (10 Marks)

Answer 1

	Value (m$)	Weight	Cost
Bond 1	3.25	18.11%	9.00%
Bond 2	4.70	26.18%	11.00%
Equity	10.00	55.71%	17.50%
Total	17.95	WACC	12.91%

Value of bond 2 = 5,000 x 940 = 4.70 million and so on.

Weight = Value / Total

Cost of bond 1 = (100 / 65)^(1/5) - 1 = 9%

Cost of equity = Rf + beta x (Rm - Rf) = 5% + 2.5 x (10% - 5%) = 17.50%

WACC = 18.11% x 9% x (1 - 30%) + 26.18% x 11% + 55.71% x 17.50% = 12.91%