Question

The stock is currently selling for $15.25 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market (i.e., Rm)is 11.50%. The firm's tax rate is 40%.1) What is the best estimate of the after-tax cost of debt (%)? i.e, (1-t)*kd?2) Based on the CAPM, what is the firm's cost of equity (%) ? i.e., ke?3) Calculate the weights of market value of debt and market value of equity for use in calculating the WACC based in market values? i.e., Wd (%) and We (%)4) Calculate ABC's WACC (%) based on your answers to 1), 2), and 3)Show all of your calculations with appropriate explanation. You won't earn any point without showing allof your calculation work.Assets Current assets 38,000,000Net plant, property, and equipment 101,000,000Total assets 139,000,000Liabilities and Equity Accounts payable 10,000,000Accruals 9,000,000Current liabilities 19,000,000Long-term debt (40,000 bonds, $1,000 par value) 40,000,000Total liabilities 59,000,000Common stock (10,000,000 shares) 30,000,000Retained earnings 50,000,000Total shareholders' equity 80,000,000Total liabilities and shareholders' equity 139,000,000

Answer 1

Answer:

5.14%

13%

0.19 or 19%

0.81 0r 81%

11.51%

Explanation:

In order to determine the after-tax cost of debt we need to determine first of all the pretax cost of debt which is the yield to maturity on the bond computed using rate formula in excel.

=rate(nper,pmt,-pv,fv)

nper is the number of coupon interest payable over twenty years which is 20 years *2=40

pmt is the semiannual interest payment=$1000*7.25%*6/12=$36.25

pv is the current price of $875

fv is the face value of $1000

=rate(40,36.25,-875,1000)=4.28%

annual yield =4.28%*2=8.56%

after tax cost of debt=8.56%*(1-40%)=5.14%

cost of equity=risk free rate(20-year treasury rate)+Beta*(Return on stock market-risk free rate)

cost of equity=5.50%+1.25*(11.5%-5.5%)=13%

Market value of equity=$15.25*10,000,000=$152,500,000.00  

Market value of bonds=$875*40,000=$35,000,000.00  

Equity plus debt                                   =$ 187,500,000

weighting of debt=$35,000,000/$187,500,000= 0.19  

weighting o equity= $152,500,000.00/$187,500,000.00 = 0.81  

WACC=Ke*We+Kd(after tax)*Wd=13%*0.81+5.14%*0.19=11.51%