Question

Answer questions 1 to 3 for Micro Advantage

Below is information regarding the capital structure of Micro Advantage Inc. On the basis of this information you are asked to respond to the following three questions: Required: 1. Micro Advantage issued a $5,650,000 par value, 19-year bond a year ago at 96 (i.e., 96% of par value) with a stated rate of 10%. Today, the bond is selling at 115 (.e., 115% of par value). If the firm's tax bracket is 35%, what is the current after-tax cost of this debt? 2. Micro Advantage has $5,650,000 preferred stock outstanding that it sold for $23 per share. The preferred stock has a per share par value of $23 and pays a $4 dividend per year. The current market price is $25 per share. The firm's tax bracket is 28%. What is the after-tax cost of the preferred stock? 3. In addition to the bonds and preferred stock described in requirements 1 and 2, Micro Advantage has 78,000 shares of common stock outstanding that has a par value of $10 per share and a current market price of $160 per share. The expected after-tax market return on the firm's common equity is 21%. What is Micro Advantage's weighted average cost of capital (WACC)?

Answer 1

face value of share =5650000 =par value of share

no of shares issued=5650000/100=56500

issue price of shares=96%of 5650000=542500

discount on issue of one share = 4$

discount on issue of total share=4$*56500=226000

effective rate of debt = debt rate(1-tax rate)

                              =10(1-35%)

                              =6.5%

current market price of bond 115

we have the formula to calculate the present market price

equation –

A- BIM H

Where:

P₀ = the current market price of the bond=115

PMT_t = the interest payment in period t   100*10%=10$

r_d= the yield to maturity =x

n = the number of periods remaining to maturity=18 years

FV = the maturity value of the bond=100

by applying above formula i.e....115=(10/1+x)¹+_^..........+(10/1+x)¹⁹+100(1+x)¹⁹(1-35%)

                                           =7.19%

similarly for prefernce shares cost of capital =25=(4/1+x)¹+......(10/1+x)¹⁹+23(1+x)¹⁹=6.32%

weighted average cost of capital =k_c=k_d(bonds capital)+k_p(prefernce capital)/total capital=7.19+6.32/2=6.755