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Homework answers / question archive / Change all % to decimals This question applies to all parts below Company A currently has a stock price $20/per share, with outstanding shares 2 Mil shares
Change all % to decimals
This question applies to all parts below
Company A currently has a stock price $20/per share, with outstanding shares 2 Mil shares. It also has outstanding debt of 20 Mil. Tax rate is 30%. Its annual bond with 10 year maturity date has a price now $886, par value $1000 and coupon rate is 7%. It has a beta of risk 1.2, risk free rate 4% and market index return 9%.
Please answer following parts with above information
Part1) what is the cost of debt before tax?
Part 2) what is the after tax cost of debt?
Part 3) how much is total equity?
Part 4) what is the cost of equity?
Part5) what is the weight of debt?
Part 6) what is the WACC?
Answer to Part 1:
Face Value = $1,000
Current Price = $886
Annual Coupon Rate = 7.00%
Annual Coupon = 7.00% * $1,000
Annual Coupon = $70
Time to Maturity = 10 years
Let Annual YTM be i%
$886 = $70 * PVIFA(i%, 10) + $1,000 * PVIF(i%, 10)
Using financial calculator:
N = 10
PV = -886
PMT = 70
FV = 1000
I = 8.76%
Annual YTM = 8.76%
Before-tax Cost of Debt = Annual YTM
Before-tax Cost of Debt = 8.76% or 0.0876
Answer to Part 2:
After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 8.76% * (1 - 0.30)
After-tax Cost of Debt = 6.13% or 0.0613
Answer to Part 3:
Number of Shares = 2,000,000
Current Price = $20
Market Value of Equity = Number of Shares * Current Price
Market Value of Equity = 2,000,000 * $20
Market Value of Equity = $40,000,000
Answer to Part 4:
Cost of Equity = Risk-free Rate + Beta * (Market Return - Risk-free Rate)
Cost of Equity = 4.00% + 1.20 * (9.00% - 4.00%)
Cost of Equity = 4.00% + 1.20 * 5.00%
Cost of Equity = 10.00% or 0.1000
Answer to Part 5:
Market Value of Debt = Face Value of Debt * Market Quote
Market Value of Debt = $20,000,000 * ($886/$1,000)
Market Value of Debt = $17,720,000
Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $17,720,000 + $40,000,000
Market Value of Firm = $57,720,000
Weight of Debt = Market Value of Debt / Market Value of Firm
Weight of Debt = $17,720,000 / $57,720,000
Weight of Debt = 0.3070
Answer to Part 6:
Weight of Equity = Market Value of Equity / Market Value of Firm
Weight of Equity = $40,000,000 / $57,720,000
Weight of Equity = 0.6930
WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.3070 * 6.13% + 0.6930 * 10.00%
WACC = 8.81% or 0.0881
