You have been given the following facts and assumptions concerning ABC Corp. at
ID: 2726219 • Letter: Y
Question
You have been given the following facts and assumptions concerning ABC Corp. at December 31, 2013. Yield to maturity on long term government bond is 5.00%. Yield to maturity on company long term government bond is 7.0%.Coupon rate on company long term bond is 7.0%.Market price of risk is 8.0% along with estimated company beta value of 1.5.Stock is selling for $40 in the market and 250 million shares are outstanding. Assuming that book value of equity is $5240 million along with book value of interest bearing debt of $1250 million. Existing tax rate stands at 35%.Given all the information estimate the appropriate weight of debt to be used when calculating ABC Corp's weighted average cost of capital.
Explanation / Answer
(A) If the Book Value is used:
Book Value of Interest bearing debt = 1250m
Book Value of the equity=5240m
Total Value of capital=1250m+5240m=6490m
Weight of debt in calculation of WACC=1250/6490=0.192
(B) If the Market Value is used:
Market Value of the Stock=250x40m = 10000m
Since the coupon rate and the YTM for the bond are same , the bond must be selling at par. So the
Market Value of the Bond=Book Value of the Bond=1250m
Total Value of capital=10000+1250=11250m
Weight of debt in calculation of WACC=1250/11250=0.111
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