Brittany Palmer works as a manager in Amanda Golden Inc. ; Brittany is trying to
ID: 2702250 • Letter: B
Question
Brittany Palmer works as a manager in Amanda Golden Inc.; Brittany is trying to determine its cost of debt. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 91 percent of the face value. The issue makes semi-annual payments and has a coupon rate 10 percent annually.
a) What is the Amanda Golden Inc.%u2019s pretax cost of debt?
b) If tax rate is 35 percent, what is the after tax cost of debt?
Stock of Amanda Golden Inc. has a beta of 1.10. Return of market portfolio is 13 percent and t-bills are currently yielding 5 percent. The company has just paid $2.00 per share and dividends are expected to grow at 7 percent annual rate indefinitely. If the stocks are traded at $36 per share, then what is your best estimate of the Amanda Golden Inc.%u2019s cost of equity?
c) Amanda Golden Inc. has a weighted cost of capital of 10 percent. Find out the Debt-Equity ratio.
d) Total Asset of Amanda Golden Inc. stands as $100,000. In dollar values, identify the Debt and Equity components of Amanda Golden Inc.
Brittany Palmer, the manager at Amanda Golden Inc. finds that this could be a good time to buy back callable bonds worth $10,000. Brittany Palmer is considering two possible options: Option A: paying $10,000 from cash balance; and Option B: raising $10,000 by issuing new stocks in the capital market and then use that to buy back $10,000 bonds. For each option: (5*2 = 10)
a. Identify Total Asset, Total Debt and Equity.
b. Calculate the Debt to Equity Ratio.
c. Calculate the WACC.
Brittany Palmer is preparing the following table for discussion with other managers (Complete the table):
As it is
Option A
Option B
Total Asset
Total Debt
Total Equity
Debt-Equity Ratio
Cost of Debt
Cost of Equity
WACC
e) Which option would you suggest? Option A, Option B or the way it is. Explain.
As it is
Option A
Option B
Total Asset
Total Debt
Total Equity
Debt-Equity Ratio
Cost of Debt
Cost of Equity
WACC
Brittany Palmer works as a manager in Amanda Golden Inc.; Brittany is trying to determine its cost of debt. The firm has a debt issue outstanding with 10 years to maturity that is quoted at 91 percent of the face value. The issue makes semi-annual payments and has a coupon rate 10 percent annually. What is the Amanda Golden Inc.%u2019s pretax cost of debt? If tax rate is 35 percent, what is the after tax cost of debt? Stock of Amanda Golden Inc. has a beta of 1.10. Return of market portfolio is 13 percent and t-bills are currently yielding 5 percent. The company has just paid $2.00 per share and dividends are expected to grow at 7 percent annual rate indefinitely. If the stocks are traded at $36 per share, then what is your best estimate of the Amanda Golden Inc.%u2019s cost of equity? Amanda Golden Inc. has a weighted cost of capital of 10 percent. Find out the Debt-Equity ratio. Total Asset of Amanda Golden Inc. stands as $100,000. In dollar values, identify the Debt and Equity components of Amanda Golden Inc. Brittany Palmer, the manager at Amanda Golden Inc. finds that this could be a good time to buy back callable bonds worth $10,000. Brittany Palmer is considering two possible options: Option A: paying $10,000 from cash balance; and Option B: raising $10,000 by issuing new stocks in the capital market and then use that to buy back $10,000 bonds. For each option: Identify Total Asset, Total Debt and Equity. Calculate the Debt to Equity Ratio. Calculate the WACC. Brittany Palmer is preparing the following table for discussion with other managers (Complete the table):Explanation / Answer
a. Semi-annual yield of bond can be calculated in Excel as =RATE(10*2,-5,91,-100). This is equal to 5.77%. So annual yield = 5.77%*2 = 11.54%. This is the pretax cost of debt
b. After tax cost of debt = 11.54%*(1-tax rate) = 11.54%*(1-35%) = 7.5%
Cost of equity (estimate 1) = risk free + beta * risk premium = 5%+1.1*(13%-5%) = 13.8%
Cost of equity (estimate 2) = next year dividend/share price + growth rate= 2*1.07/36 + 7% = 12.94%
So best estimate = average of both estimates = (13.8%+12.94%)/2 = 13.37%
c. Let debt equity ratio be X.
WACC = X/(1+X) * cost of debt + 1/(1+X)*cost of equity
So 10% = X/(1+X) * 7.5% + 1/(1+X) * 13.37%. Solving we get X = 1.348
d. Debt = 1.348*equity. Total assets = Debt+equity = 1.348*equity + equity = 2.348*equity = 100,000. So equity = 42,589 and debt = 1.348*42,859 = 57,411
Brittany Palmer's table below:
e. Best option is as it is, as any other option increases the WACC from its current level.
As it is Option A Option B Total Assets 100,000 90,000 100,000 Total Debt 57,411 47,411 47,411 Total Equity 42,589 42,589 52,589 Debt/equity ratio 1.348 1.113 0.902 Cost of debt 7.50% 7.50% 7.50% Cost of equity 13.37% 13.37% 13.37% WACC 10.00% 10.28% 10.59%Related Questions
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