WACC Your firm has the following balance sheet: L-T Debt (8%) 1,000,000 Common S

Question

WACC Your firm has the following balance sheet: L-T Debt (8%) 1,000,000 Common Stock ($10 par) 200,000 Retained Earnings 750,000 Total Assets 1,950,000 Total Liabs. & Equity 1,950,000 The bonds have a par value of $1,000 each and mature in 10 years The current market price of the bonds is $1,000 The current stock price is $60 per share The dividend that the company paid last year was $2.00 and is growing at a 5% rate which is expected to continue indefinitely into the future The tax rate is 40% A. What is the market value of the debt? What is the market value of the equity? B. What is the market rate of interest on the debt? What is the stockholders' required rate of return? C. What is the weighted average cost of capital of the firm?

Explanation / Answer

Requirement A:

Number of bonds = 1000000 / 1000 = 1000

Market Value of debt = Market Value per bond * Number of bonds = $1000 * 1000= $1000000

Number of Equity Shares = $200000 / 10 = 20000

Market Value of Equity = Mrket Value per share * Number of shares = $60 * 20000 = $1200000

Requirement B:

Since the par value of debt and the market value of debt are same, the market rate of interest shall equal the coupon rate.

Market Rate of interest on the debt = Coupon rate = 8%

Stockholders' Required Rate of Return

= [Last year Dividend (1+growth rate) / Market Price] +growth rate

= [ 2 (1+0.05) / 60] + 0.05

= 0.085

= 8.5%

Requirement C:

Weighted Average Cost of Capital

WACC = 8.27%

Type Capital Cost of Capital Capital Weight Weighted Cost Debt 8 1000000 0.454545455 3.64 Equity 8.5 1200000 0.545454545 4.64 2200000 8.27

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