ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100, 6% coupon rate, and 10 years to maturity. The common stock has a standard deviation of return of 30% and a correlation coefficient with S&P 500 return of 0.75. The S&P500 has a return of 12.5% and a standard deviation of return of 20%. The T-bill rate is 3.5%. The debt has a default risk premium of 2% and a maturity risk premium of 1%. The stockholders are expected to receive a dividend of $2 five years hence and a stock price of $105 five years hence. ABC Inc. has a corporate tax rate of 30%.
Cost of common stock = risk free retrun + beta * ( market return - risk free return = 3.5% + 0.75 ( 12.5% - 3.5% )
= 3.5% + 6.75%
= 10.25%
Cost of debt = coupon rate ( 1- tax rate )
= 6% * ( 1 - 0.3)
= 4.2%
Weighted average cost of capital = ke * Pe + Kd * Pd
= 10.25% * 1000000/1300000 + 4.2% * 300000/1300000
= 8.854%
Where ke = cost of equity
Pe = Proportion of equity
Kd = cost of debt
Pd = proportion of debt
If return of investment is 10% then the same is higher than wacc of 8.854% therefore investments are viable.
ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of...
can someone solve step by step, please ABC Inc. has 10,000 shares of common stock and 3,000 units of debt. Each unit of debt has a face value of $100,6% coupon rate, and 10 years to maturity. The common stock has a standard deviation of return of 30% and a correlation coefficient with S&P 500 return of 0.75. The S&P500 has a return of 12.5% and a standard deviation of return of 20%. The T-bill rate is 3.5%. The debt...
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