Malitz Inc. recently hiredyou as a consultant to estimate the company’s WACC. Yo
ID: 2770585 • Letter: M
Question
Malitz Inc. recently hiredyou as a consultant to estimate the company’s WACC. You haveobtained the following information. (1) Malitz’s noncallablebonds mature in 25 years, have an 8.00% annual coupon, a par valueof $1,000, and a market price of $1,075.00. (2) The company’stax rate is 40%. (3) The risk-free rate is 4.50%, the market riskpremium is 5.50%, and the stock’s beta is 1.20. (4) Thetarget capital structure consists of 35% debt and the balance ascommon equity. Malitz uses the CAPM to estimate the cost of equity,and it does not expect to issue any new common stock. What is itsWACC? Malitz Inc. recently hiredyou as a consultant to estimate the company’s WACC. You haveobtained the following information. (1) Malitz’s noncallablebonds mature in 25 years, have an 8.00% annual coupon, a par valueof $1,000, and a market price of $1,075.00. (2) The company’stax rate is 40%. (3) The risk-free rate is 4.50%, the market riskpremium is 5.50%, and the stock’s beta is 1.20. (4) Thetarget capital structure consists of 35% debt and the balance ascommon equity. Malitz uses the CAPM to estimate the cost of equity,and it does not expect to issue any new common stock. What is itsWACC? 7.13% 7.51% 7.90% 8.32% 8.76% Malitz Inc. recently hiredyou as a consultant to estimate the company?s WACC. You haveobtained the following information. (1) Malitz?s noncallablebonds mature in 25 years, have an 8.00% annual coupon, a par valueof $1,000, and a market price of $1,075.00. (2) The company?stax rate is 40%. (3) The risk-free rate is 4.50%, the market riskpremium is 5.50%, and the stock?s beta is 1.20. (4) Thetarget capital structure consists of 35% debt and the balance ascommon equity. Malitz uses the CAPM to estimate the cost of equity,and it does not expect to issue any new common stock. What is itsWACC? 7.13% 7.51% 7.90% 8.32% 8.76%Explanation / Answer
(1) Number of years to Maturity (t) = 25 years
Annual Coupon rate ( C) = 8.00% ($1000*8%)
Par Value of the bond (F) =$1,000
Market Price of the bond =$1,075.00
Bond Value= Present Value of the Coupons + Present Value of the faceamount
Bond Value = C *[1-1/(1+r)t]/r + F/(1+r)t
$1,075 = $80 [1-1/(1+r)25]/r +$1,000 / (1+r)25
(2) Tax Rate = 40%
Calculating Cost of Debt After Tax:
Cost of debt (kd) = kd (1-T)
kd = 7.34% (1-0.4)
= 0.0734 * 0.6
=0.04404 (or) 4.404%
(3) Risk-free rate (Rf) = 4.50%
Market risk premium(Rm) = 5.50%
Beta(ß) = 1.20
Calculating Cost of Equity Using CAPM:
Cost of Equity (ks) = Risk-free rate (Rr)+ ß * (Market Risk premium) Rm
= 4.50% + 1.20 * 5.50%
= 0.045 + 1.20 *0.055
= 0.045 + 0.066
= 0.111 (or) 11.1%
(4) Target Capital Structure:
Equity (wc ) - 65% (0.65)
Debt (wd ) - 35%(0.35)
Calculating Weighted Average Cost of Capital(WACC):
WACC= wd kd (1-T) + wc ks
WACC = (0.35*0.04404) + (0.65 * 0.111 )
= 0.015414 + 0.07215
= 0.087564 (or) 8.76%%
Weighted Average Cost of Capital(WACC) = 8.76%
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