Use the following information for 3-7. A company has 9,000,000 shares of stock o
ID: 2735467 • Letter: U
Question
Use the following information for 3-7. A company has 9,000,000 shares of stock outstanding with a price of $60 per share. The firm just paid a dividend of $3 and the dividend is expected to grow at a constant rate of 5% forever. The stock has a beta of .9, the risk free rate is 3% and the Market Risk Premium is 7%. The firm also has 200,000 bonds outstanding at a price of $950 per bond. The bonds mature in 9 years, have a face value of $1000, and have a coupon rate of 6% with semiannual payments. The firm expects to change their capital structure and will have a future debt ratio of 70%, a cost of equity (required return) of 14%, and a cost of debt (Yield to Maturity) of 9%. The firm has a marginal tax rate of 40%.
3. What is the yield to maturity on their debt (Cost of Debt)?
a. 5.75% b. 6.25% c. 6.75% d. 7.25% e. 7.75%
4. What is their current percent debt using market value capital structure?
a. 26% b. 35% c. 54% d. 65% e. 82%
5. What is their Weighted Average Cost of Capital using their future expected capital structure, cost of equity and cost of debt?
a. 7.4% b.8% c. 8.3% d. 9.1% e. 10.4%
6. What will be their new stock price given the new required return?
a. $24 b. $35 c. $42 d. $56 e. $62
7. What will be their new bond price given the new Yield to Maturity?
a. $818 b. $882 c. $974 d. $1,043 e. $1,112
Explanation / Answer
3.
Calculation of the cost of debt:
= 9% (1-0.40)
= 9% × 0.60
= 5.40%
Therefore, the correct answer is option A. the cost of debt is 5.75% (approximate).
4.
Calculate the current percent debt using market value capital structure:
Details
No. of issues
Each share
Amount
Percentage
Shares
9,000,000
60
$ 540,000,000
72.97
Bonds
200,000
1,000
$ 200,000,000
27.03
Total
$ 740,000,000
100.00
Therefore, the correct answer is option A. The debt percentage is 26.00%.
5.
Calculation of the weighted average cost of capital using their future expected capital structure, cost of equity and cost of debt:
Details
No. of issues
Each share
Amount
Weights
Cost of debt
WACC
Shares
9,000,000
60
$ 540,000,000
74.00
0.0575
4.255
Bonds
200,000
1,000
$ 200,000,000
26.00
0.14
3.64
Total
$ 740,000,000
100.00
7.895
Therefore, the correct answer is option b. The WACC is 8%.
6.
Calculate the required return for new stock:
E(R) = Rf + (Rm-Rf)
= 3 + 0.9 (7%)
= 3.0 + 6.3
= 9.30%
Therefore, the correct answer is option a.
Details
No. of issues
Each share
Amount
Percentage
Shares
9,000,000
60
$ 540,000,000
72.97
Bonds
200,000
1,000
$ 200,000,000
27.03
Total
$ 740,000,000
100.00
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