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Homework answers / question archive / Williams Inc is an all equity financed firm operating in Nova Scotia

Williams Inc is an all equity financed firm operating in Nova Scotia

Finance

Williams Inc is an all equity financed firm operating in Nova Scotia. The firm has 1,000,000 shares outstanding trading for $25 per share. Additionally, the firm plans to pay all its future earnings as cash dividends to its shareholders.

 

The current return on Government of Canada T-Bills is 2%, the return on the market portfolio is 10% and William's estimated beta is 1.20.

 

Practice Question 1: Consider a world with no taxes and no bankruptcy costs:

 

a)   What is the market value of Williams Inc?  (remember 3 decimal places).

 

b)   According to CAPM, what is the cost of equity for Williams Inc?

 

c)   What is the WACC for Williams Inc?  

 

d)   Williams Inc is considering borrowing $1,000,000 at 5% and using the proceeds to repurchase some shares.  Briefly explain in words using the numbers as part of your decription, the impact this will have on the market value of the firm and on the WACC.

 

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a) Computation of Market Value of Williams Inc.:

Market Value of Williams Inc. = Number of Shares*Price per Share

= 1,000,000*$25

= $25,000,000

 

b) Computation of Cost of Equity for Williams Inc.:

Cost of Equity = Risk-free Rate + Beta*(Market Rate of Return - Risk-free Rate)

= 2% + 1.20*(10%-2%)

= 2% + 1.20*8%

= 2% + 9.6%

Cost of Equity = 11.6%

 

c) Computation of WACC for Williams Inc.:

Since it is an all equity firm. So, WACC = Cost of Equity = 11.6%

 

d) Market Value of the Firm = Market Value of Equity + Market Value of Debt

= $25,000,000 + $1,000,000

= $26,000,000

 

WACC = Weight of Equity*Cost of Equity + Weight of Debt*Cost of Debt

WACC = ($25,000,000 /$26,000,000)*0.116 + ($1,000,000/$26,000,000)*0.05

= 0.11154 + 0.00192

WACC = 0.11346 or 11.346%

 

So, $1,000,000 at 5% and using the proceeds to repurchase some shares will increase the market value of firm by $1,000,000 and WACC decrease from 11.6% to 11.346%.

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