a]
cost of equity = risk free rate + (beta * (expected market return - risk free rate))
cost of equity = 4.25% + (0.9 * (10% - 4.25%)) = 9.425%
b]
cost of equity = (next year dividend / net proceeds per share) + growth rate.
growth rate = ROE * (1 - payout ratio)
growth rate = 10% * (1 - 60%) = 4%
next year dividend = last dividend * (1 + growth rate)
next year dividend = $1.50 * (1 + 4%) = $1.56
net proceeds per share = price of share - flotation cost
net proceeds per share = $30 - ($30 * 4.75%) = $28.575
cost of equity = ($1.56 / $28.575) + 4%
cost of equity = 9.46%
c]
cost of debt = YTM of bond * (1 - tax rate)
YTM is calculated using RATE function in Excel with these inputs :
nper = 10*2 (10 years to maturity with 2 semiannual coupon payments each year)
pmt = 100 * 5.75% / 2 (semiannual coupon payment = face value * annual coupon rate / 2. This is a positive figure as it is an inflow to the bondholder)
pv = -93 (Net proceeds per bond. Net proceeds = current bond price * (1 - flotation costs) = $96.54 * (1 - 3.67%) = $93.00. This is a negative figure as it is an outflow to the buyer of the bond)
fv = 1000 (face value of the bond receivable on maturity. This is a positive figure as it is an inflow to the bondholder)
The RATE is calculated to be 3.36%. This is the semiannual YTM. To calculate the annual YTM, we multiply by 2. Annual YTM is 6.72%
cost of debt = YTM * (1 - tax rate)
cost of debt = 6.72% * (1 - 40%) ==> 4.03%
d]
market value of equity = shares outstanding * price per share
market value of equity = 100,000 * $30 = $3,000,000
market value of debt = book value * quoted price as a % of par
market value of debt = $1,000,000 * 96.54% = $965,400
value of firm = $3,000,000 + $965,400 = $3,965,400
market value weight of equity = ($3,000,000 / $3,965,400) = 0.757
market value weight of debt = ($965,400 / $3,965,400) = 0.243
Problem 27 Mark) Philips Pharmaceuticals Limited (PPL) shares are publicly traded on the Toronto Stock Enchone....
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