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A firm is 30% debt and 70% equity
A firm is 30% debt and 70% equity. The firm's tax rate is 40%. Their bonds trade for $990, mature in five years, and have a coupon rate of 8% paid annually. The firm's common stock trades at $15 per share and just paid a dividend of $3per share. The dividends are expected to grow at a rate of 3% per year forever.
The bond's yield is ____ %
The required rate of return for the company's common stock is ____ %.
The cost of financing for this firm (WACC) is_____ %.
Expert Solution
We can calculate the bond's yield by using the following formula in excel:-
=rate(nper,pmt,-pv,fv)
Here,
Rate = Bond's yield
Nper = 5 periods
Pmt = Coupon payment = $1,000*8% = $80
PV = $990
FV = $1,000
Substituting the values in formula:
= rate(5,80,-990,1000)
= 8.25%
Computation of the required rate of return (Cost of common equity):-
Required rate of return = (D1 / Current stock price) + Growth rate
= ($3 * (1 + 3%) / $15) + 3%
= ($3.09 / $15) + 3%
= 20.60% + 3%
= 23.60%
Computation of the WACC:-
WACC = (Weight of debt * After tax cost of debt) + (Weight of equity * Cost of equity)
= (30% * 8.25% * (1 - 40%)) + (70% * 23.60%)
= 1.49% + 16.52%
= 18.01%
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