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ID: 2725135 • Letter: H
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home / study / business / finance / questions and answers / assume that you have been hired as a consultant ... Question Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
Assets
Current assets $ 38,000,000
Net plant, property, and equipment 101,000,000
Total assets $139,000,000
Liabilities and Equity
Accounts payable $ 10,000,000
Accruals 9,000,000
Current liabilities $ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value) 40,000,000
Total liabilities $ 59,000,000
Common stock (10,000,000 shares) 30,000,000
Retained earnings 50,000,000
Total shareholders' equity 80,000,000
Total liabilities and shareholders' equity $139,000,000
The stock is currently selling for $14.00 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $800.00. The beta is 0.85, 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 is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.
What is the best estimate of the firm's WACC?
a.
b.
c.
d.
e.
What is the best estimate of the firm's WACC?
a.
10.85%b.
11.82%c.
8.33%d.
9.69%e.
9.11%Explanation / Answer
Answer : Answer "B' is correct. That is 11.82%.
Calculation of Weight of stock & debt in Capital Sl. no. Particulars Qty Current Market Rate Current Market value Weight 1 Common Stock 10000000 14 140000000 81.40% 2 Bond 40000 800 32000000 18.60% ---------------------------- ----------------- Total Market Value of stock & debt 172000000 100.00% ---------------------------- '---------------- Calculation of cost Cost of Equity = Risk Free rate+beta *Market risk premium =7+0.85(14.50-7) '=13.375% Cost of Debt = Present interest payable = 1000*7.25% = $ 72.50 Actual bond sale 800 actual interest rate = 72.50/800*100 = 9.06% Debt cost '= rd(1-tax rate) =9.06*(1-0.4) =5.44% Calculation of WACC Weight Cost Weight * Cost Sl. no. Particulars 81.40% 13.37% 10.88% 1 Common Stock 18.60% 5.44% 1.01% 2 Bond ----------------- ----------------- Total 100% 11.90% '---------------- '---------------- WACC = 11.90%Related Questions
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