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Number of equity shares outstanding: 10 million Current stock price per share: $400 Short term debt on balance sheet: $0 Long term debt on balance sheet: $2,000 Equity on balance sheet: $1,500 Number of bonds issued: 20 million Current price for each bond: $90 Coupon Rate of Bonds: 6% Bonds Rating: B (Avg Debt Beta = 0
Number of equity shares outstanding: 10 million
Current stock price per share: $400
Short term debt on balance sheet: $0
Long term debt on balance sheet: $2,000
Equity on balance sheet: $1,500
Number of bonds issued: 20 million
Current price for each bond: $90
Coupon Rate of Bonds: 6%
Bonds Rating: B (Avg Debt Beta = 0.26)
Tax Rate: 35%
Question: The firm has zero excess cash. Suppose the risk-free rate is 2% and expected market return is 6%, then the firm's WACC minus its asset cost of capital equals ___%
Expert Solution
Computation of the WACC:-
Market value of debt = 20 * $90
= $1,800 million
Market value of equity = 10 * $400
= $4,000 million
Total value = $1,800 + $4,000
= $5,800
Weight of debt = Market value of debt / Total value
= $1,800 / $5,800
= 31.03%
Weight of equity = Market value of equity / total value
= $4,000 / $5,800
= 68.97%
Cost of equity = Risk free rate + Beta * (Expected market return - Risk free rate)
= 2% + 0.26 * (6% - 2%)
= 2% + (0.26 * 4%)
= 2% + 1.04%
= 3.04%
Cost of debt = Coupon rate =6%
WACC = (Weight of debt * Cost of debt * (1 - Tax rate)) + (Weight of equity * Cost of equity)
= (31.03% * 6% * (1 - 35%)) + (68.97% * 3.04%)
= 1.21% + 2.10%
= 3.31%
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