Question

WACC Estimation On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm's present market value capital structure, here below, is considered to be optimal. There is no short-term debt. Debt Common equity Total capital $30,000,000 30,000,000 $60,000,000 New bonds will have an 6% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividende s $1.20/530-4% The marginal tax rate is 30% a. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Write out your answers completely. For example, 13 million should be entered as 13,000,000. Round your answer to the nearest dollar b. Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC7 Round your answer to two decimal places. c. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC No numbers are required to answer this question. I. Is and the WACC will not be affected by flotation costs of new equity. II. rs and the WACC will increase due to the flotation costs of new equity. III. Is and the WACC will decrease due to the flotation costs of new equity. IV.rs will increase and the WACC will decrease due to the flotation costs of new equity V.rs will decrease and the WACC will increase due to the flotation costs of new equity. Select-

Answer 1

a.

Total capital is $60,000,000. The debt value is $30,000,000. The equity value is also $30,000,000. This means the firm’s current capital structure consists 50% of debt and 50% of equity.

It requires new funds of $30,000,000.

To maintain the present capital structure, the new investment funds can be raised using 50% of debt and 50% of equity.

Calculate the amount raised through equity financing.

b.

Calculate the WACC.

Here, the cost of debt is 6% which is equal to coupon rate as the bond is selling at par value.

c.

Issuing new shares of stock increases the floatation costs which leads to an increase in the cost of equity when compared to the existing cost of equity. Hence, with an increase in cost of equity, the WACC will increase.

Therefore, the correct answer is option II.