- 4 of 5 ID: FMTH.CC.CD.02
Gertrude's Great Gloves issue bonds with a face value of $10,000, paying interest at j2 = 11%, redeemable in exactly 12 years. An investor purchases the bond for $10,132.77. Calculate the cost of debt (j2) for Gertrude's Great Gloves. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.
Cost of debt = % pa
- 5 of 5 ID: FMTH.CC.WACC.07A
The following data applies to Micro Advanced Developers (MAD).
Debt | Equity |
---|---|
market value of debt = $81,479 | market value of equity = $40,978 |
time to maturity of debt = 7 years | risk free rate = 4.6% pa |
coupon rate = 5.2% pa paid semi-annually | market risk premium = 7.9% pa |
face value = $100,000 | DDD beta = 1.11 |
As a financial manager you have been given the task of calculating the company's weighted average cost of capital (WACC). Ignore the effect of taxes.
a)Firstly, you realise that the cost of debt is needed. Calculate the cost of debt for MAD. You may give your answer as a percentage per annum to the nearest percent or use linear interpolation or a financial calculator to give a more accurate result.
Cost of debt = % pa
b)Secondly, the cost of equity must also be identified. Calculate the cost of equity for MAD. Give your answer as a percentage per annum to 1 decimal place.
Cost of equity = % pa
c)Finally, calculate the weighted average cost of capital for MAD. Give your answer as a percentage per annum to 1 decimal place.
Weighted average cost of capital = % pa
Q.No. 4.5 | ||||
Solution:- | ||||
Face value of Bond | 10000 | |||
Paying Interest | 11% | |||
Redeemable in | 12 Years | |||
Market value | 10132.77 | |||
Determining the intrensic value of bond using desired rate of return as 10% | ||||
year | Cash Flow | PVF@10% | Pv of CF | |
1-12 | 1100 | 6.8137 | 7,495.07 | |
12 | 10000 | 0.3186 | 3,186.00 | |
Intransic Value | 10,681.07 | |||
Market value is $10,132.77, which is lower than intransic value @10% | ||||
Determining the intrensic value of bond using desired rate of return as 11% | ||||
year | Cash Flow | PVF@11% | Pv of CF | |
1-12 | 1100 | 6.4924 | 7,141.64 | |
12 | 10000 | 0.2858 | 2,858.00 | |
Intransic Value | 9,999.64 | |||
Market value is $10,132.77, which is greater than intransic value @11% | ||||
Therefor Cost of debt will be between 10% to 11% | ||||
By using interpolation for determining cost of debt | ||||
10% | Change for 1% | 11% | ||
10,681.07 | 681.43 | 9,999.64 | ||
Difference of market value (10681.07-10132.77) | 548.30 | |||
Cost of Debt | =10%+548.30/681.43*1 | |||
10.80 | % | |||
Q.No. 5.5 | ||||
Solution:- | ||||
Cost of Debt Kd(Working Note 1) | 13.84 | % | ||
Cost of Equity Ke | =Rf+Beta(ER(m)-Rf) | |||
=4.6+1.11*7.9 | ||||
13.37 | % | |||
Calculation of Waighted Average Cost of capital | ||||
Capital Structure | Amount | Weight | Cost | WACC |
Debt | 81479 | 0.67 | 13.84 | 9.21 |
Equity | 40978 | 0.33 | 13.37 | 4.47 |
Total | 122457 | 1.00 | 13.68 | |
Waighted Average Cost of capital | 13.68 | % | ||
Working Note 1 | ||||
Determining the intrensic value of Debt using desired rate of return as 10% | ||||
year | Cash Flow | PVF@10% | Pv of CF | |
1-12 | 10400 | 6.8137 | 70,862.48 | |
12 | 100000 | 0.3186 | 31,860.00 | |
Intransic Value | 102,722.48 | |||
Market value is $81479, which is lower than intransic value @10% | ||||
Determining the intrensic value of Debt using desired rate of return as 15% | ||||
year | Cash Flow | PVF@15% | Pv of CF | |
1-12 | 10400 | 5.4206 | 56,374.24 | |
12 | 100000 | 0.1869 | 18,690.00 | |
Intransic Value | 75,064.24 | |||
Market value is $81479, which is greater than intransic value @11% | ||||
Therefor Cost of debt will be between 10% to 15% | ||||
By using interpolation for determining cost of debt | ||||
10% | Change for 1% | 15% | ||
102,722.48 | 27,658.24 | 75,064.24 | ||
Difference of market value | 21,243.48 | |||
Cost of Debt | =10%+21243.48/27658.24*5 | |||
13.84 | % |
- 4 of 5 ID: FMTH.CC.CD.02 Gertrude's Great Gloves issue bonds with a face value of...
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