Answer:
Year Cashflow [email protected]% PV [email protected]% PV
$ $ $
0 (905) 1 (905) 1 (905)
1-16 52.80 7.8237 413 10.8377 572
16 1,000 0.2176 218 0.4581 458
NPV (274) NPV 125
Kd = LR + NPV1/NPV1+NPV2 x (HR – LR)
Kd = 5 + 125/125 + 274 x (10 – 5)
Kd = 5 + 125/399 x 5
Kd = 6.57%
Ke = D1/Po + g
Ke = $3/$20 + 0.04
Ke = 0.19 = 19%
WACC = Ke(E/V) + Kd(D/V)
WACC = 19(160,000,000/196,200,000) + 6.57(36,200,000/196,200,000)
WACC = 15.49 + 1.21
WACC = 16.7%
Market value of the company $
Market value of equity (8,000,000 x $20) 160,000,000
Market value of bond ($40,000,000 x $905/$1,000) 36,200,000
Market value of the company 196,200,000
Explanation:
In this case, we will calculate cost of debt using interpolation formula. The cashflow for year 0 is the current market price while the cashflow for year 1 to 16 refers to after-tax coupon, which is calculated as R(1-T). R = 8% x $1,000 par value = $80. Then, R(1-T) = 80(1-0.34) = $52.80. The cashflow for year 16 is the par value. The cashflows are discounted in order to obtain the cost of debt.
Cost of equity is the ratio of expected dividend to current market price plus growth rate.
WACC is the aggregate of cost of each capital multiplied by the proportion of each stock in the market value of the company.
