Question

o o 10) rCapital (WACC) for your i nformation provided (20 pts) You need od time w company. You have the the the Av balance sheet Current Assets Net Plant, Property, and Equipment $38.000.000 101.000.000 $139,000,000 Total Assets $10.000.000 2,000,000 $19,000,000 Liabilities and Equity Accounts Payable Accruals Current Liabilities Long-term Debt (40.000 bonds, $1,000 face value) Total Liabilities $40.000.000 $59,000,000 Common Stock (10,000,000 shares) Retained Earnings Total Shareholder Equity $30,000,000 50.000.000 $80,000,000 $139,000,000 Total Liabilities and Shareholders Equity You check The Wall Street Journal and see that your company's stock is currently selling for $7.50 per share and that its bonds are selling for $889.50 per bond. These bonds have a 7.25% annual coupon rate, with semi-annual payments. The bonds mature in twenty years. Your company's beta is approximately equal to 1.25. The yield on a 6-month Treasury bill is 3.5% and the yield on a 10-year Treasury bond is 5.5%. The expected return on the stock market is 11.5%, but the stock market has had an average annual return of 10.5% during the past 5 years. Your firm is in the 40% tax bracket. NOTE: Make sure to show your work in order to receive credit. Using the Security Market Line (CAPM) method, what is the best estimate for the cost of equity? Show Work in Space Below

Answer 1

a) Using CAPM, Cost of equity, re = Rf + beta x (Rm - Rf) = 3.5% + 1.25 x (11.5% - 3.5%) = 13.50%

b) Before-tax cost of debt is the YTM on the bonds, which can be calculated using I/Y function

N = 20, PMT = 7.25% x 1000 = 72.5, FV = 1000, PV = -889.50

=> Compute I/Y = 8.41%

After-tax cost of debt, rd = 8.41% x (1 - 40%) = 5.05%

c) Weight = Value / Total

Value of equity = No. of shares x Price and Value of debt = No. of bonds x Price

	Value (m)	Weight	Cost
Equity	75.00	67.82%	13.50%
Debt	35.58	32.18%	5.05%
Total	110.58	WACC	10.78%

d) WACC = wd x rd + we x re = 10.78%