Drexel Corp has a target debt ratio (debt/value) of 60%. The 10-year bonds have
ID: 2654507 • Letter: D
Question
Drexel Corp has a target debt ratio (debt/value) of 60%. The 10-year bonds have a coupon rate of 8.3% (paid annually) and currently trade for $1125 per bond. The tax rate is 30%. They have the following information on their stock (You will need to fill in the blanks):
Current EPS
Current Dividend
Return on Equity
Current Price
Payout Rate = Div/EPS
Growth = Retention x ROE
a) Calculate the weighted average cost of capital.
b) The firm has a 3-year planning period. The firm expects cash flows of $6M next year, and the cash flows will initially grow at the growth rate. After year 3, they estimate that the cash flows will start to grow at 2% indefinitely. Find the value of the operations.
d) The firm has $8M in cash, $2M in debt and 5M shares outstanding. Find the share price.
Current EPS
8Current Dividend
6Return on Equity
20%Current Price
$50Payout Rate = Div/EPS
Growth = Retention x ROE
Explanation / Answer
Cost of debt Face value $1,000.00 Coupon Rate 8.30% Current value $1,125.00 Nper 10 Rate (calculated in excel) (cost of Debt) 6.56% Cost of debt after tax (6.56% x 1-30%) 4.590% Cost of Equity Current EPS $8.00 Current Dividend (D0) $6.00 Return on Equity 20% Current Price (P0) $50.00 Payout Rate = Div/EPS 75.00% Retention ratio = (1- payout) 25.00% Growth (g)= Retention x ROE 5.00% Weights Cost WACC Debt 60% 4.590% 2.754% Equity 40% 20.000% 8.000% WACC 10.754% b. Year Cash flow PV @ 10.754% Present Value 1 $6,000,000.00 0.90290384 $5,417,423.04 2 6000000*(1+5%) $6,300,000.00 0.815235344 $5,135,982.67 3 2% indefinitely $73,408,410.48 0.815235344 $59,845,130.76 Value of operation $70,398,536.46 Cashflow In year 3 = $6,300,000 x(1+2%)/(10.754%-2%)
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