Bay State Technology has determined that its cost of equity is 15% and its after

Question

Bay State Technology has determined that its cost of equity is 15% and its after-tax cost of debt is 7.2%. Bay State expects to earn $14 million after taxes next year and, as a new firm, does not pay any dividends. The stock sells for $24. Bonds are currently selling at par value. Compute Bay State's weighted cost of capital. A partial balance sheet is shown below: Current liabilities $ 300,000 Long-term debt 1,000,000 Common stock at $1 par 100,000 Paid in capital 900,000 Retained earnings 3,000,000 Total liabilities and stockholders' equity $5,300,000

Explanation / Answer

$1,000,000

2,400,000

$3,400,000

Capital structure: Debt = $1/$3.4 = 29.41%
     Equity=2.4/3.4 = 70.59%
ka = 0.2941(7.2%) + 0.7059(15.0%) = 12.71% correct answer (as per my prof)

Solution: Capital structure: Debt =

$1,000,000

Market value of Equity: 100,000 shares($24) =

2,400,000

     Total

$3,400,000

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