1a Bonds Book Value Book Value Weight 1. $3 B 2. $1 B 3. $2 B 4. $2 B Weighted A
ID: 2787503 • Letter: 1
Question
1a
Bonds
Book Value
Book Value Weight
1.
$3 B
2.
$1 B
3.
$2 B
4.
$2 B
Weighted Average Cost of Debt (based on book values)
Weighted Average Cost of Debt (based on market values)
Which is more appropriate?
1b
Weighted Average Cost of Capital (based on book values of debt and equity) – show calculations
Weighted Average Cost of Capital (based on Market values of debt and equity) – show calculations
Which is more relevant?
1c
Any potential problems with this pure play approach?
What improvements do you suggest to better reflect the WACC of SMI?
Book Value of Equity
$4,711,480
Stock Price
310.11
Market Value of Equity (market Capitalization)
52.119B
Number of Shares Outstanding
168.07M
Stock Beta
0.73
3-month T-bill rate
1.06
Cost of Equity
6.17%
Debt
1a
Bonds
Book Value
Book Value Weight
1.
$3 B
2.
$1 B
3.
$2 B
4.
$2 B
Weighted Average Cost of Debt (based on book values)
Weighted Average Cost of Debt (based on market values)
Which is more appropriate?
1b
Weighted Average Cost of Capital (based on book values of debt and equity) – show calculations
Weighted Average Cost of Capital (based on Market values of debt and equity) – show calculations
Which is more relevant?
1c
Any potential problems with this pure play approach?
What improvements do you suggest to better reflect the WACC of SMI?
Explanation / Answer
In order to calculate weights, we need to sum up the values and different each value by the total
For Book Value, Total = 3 + 1 + 2 + 2 = $8 B
Book Weight of Bond 1 = 3 / 8 = 37.50% and so on for other bonds
For Market Value, Total = 2.6 + 0.92 + 2.14 + 1.86 = 7.52
Market Weight of Bond 1 = 2.6 / 7.52 = 34.57% and so on..
Weighted average cost of debt using book value
= 37.50% x 4.35% + 12.50% x 3.92% + 25% x 2.25% + 25% x 2.86%
= 3.40%
Weighted average cost of debt using market value
= 34.57% x 4.35% + 12.23% x 3.92% + 28.46% x 2.25% + 24.73% x 2.86%
= 3.33%
The market values are more appropriate than the book values.
Bonds Book Value Weight Market Value Weight YTM 1 3 37.50% 2.6 34.57% 4.35% 2 1 12.50% 0.92 12.23% 3.92% 3 2 25.00% 2.14 28.46% 2.25% 4 2 25.00% 1.86 24.73% 2.86% Total 8 3.40% 7.52 3.33%Related Questions
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