Question

Easy Car Corp. is a grocery store located in the southwest. It paid an annual dividend of $10.00 last year to its share holders and plans to increase the dividend annualy at a rate of 4.0% forever. It currently has 600.00 common shares outstanding. The shares currently sell for $50 each. Easy Car Corp. also has 20,000 semi annual bonds outstanding with coupon rate of 8.9141%, a maturity of 26years, and a par value of 1,000. The bonds currently have a YTM of 10%. The corporate tax rate is 25%

Multi parts

a.What is the cost of debt for easy corp as a percent?

b.How many interest payments are left for the bond of Easy Corp?

c.What is the interest payment per period for the bond?

d. What is the discount rate perperiod to use in pricing the bonds?

e.What is me market value of equity for the calculation of the WACC for Easy?

f.Ehat is the cost of equity foe Easy?

g.Waht is the market value of debt to be used in the calculation of the Wacc for easy?

h.What id the valu of D/V?

i.What is the weighted averge cost of capital (WACC) for Easy Corp?

Answer 1

a) Cost of debt = After tax YTM of bond

Cost of debt = YTM * (1 - tax rate)

Here, YTM = 10% or 0.10

Tax rate = 25% or 0.25

Now,

Cost of debt = 0.10 * (1 - 0.25)

Cost of debt = 0.10 * 0.75

Cost of debt = 0.0750 or 7.50%

b) No. Of interest payments = No. Of compoundings per year * No. Of years

No of interest payments = 2 (semi annual) * 26 years

No. Of interest payments = 52

c) Interest payment per period (ie. Semi annual) = Par value * Coupon rate * 6/12 months

Interest payment per period = $1,000 * 8.9141% * 6/12 months

Interest payment per period = $44.57

d) Discount rate per period for bond = YTM * 6/12 months

Here, YTM = 10% or 0.10

Discount rate = 0.10 * 6/12

Discount rate (per period ie semi annual) = 0.05 or 5%

e) Market value of equity = Shares outstanding * Price

Market value of equity = 600 shares * $50

Market value of equity = $30,000

f) Cost of equity (Ke) :

Price = D1 / (Ke - g)

Here,

Price = $50

g (growth rate) = 4% or 0.04

D1 (Expected dividend) = Current dividend + growth

D1 = $10 + ($10 * 4%) = $10 + $0.40

D1 = $10.40

Now,

$50 = $10.40 / (Ke - 0.04)

Ke - 0.04 = $10.40 / $50

Ke - 0.04 = 0.2080

Ke = 0.2080 + 0.04

Ke = 0.2480 or 24.80%

g) Market value of debt calculations :

a) Price of bond = Coupon * ((1 - (1/(1+i)^n)) / i) + Par value * (1 / (1+i)^n)

Here,

Par value = $1,000

Coupon = Par value * Coupon * 6/12 months

Coupon = $1,000 * 8.9141% * 6/12 = $44.57

i (Discount rate - refer d) = 0.05

n (years - refer b) = 52 period

Now,

Price of bond = $44.57 * ((1 - (1/(1+0.05)^52)) / 0.05) + $1,000 * (1 / (1+0.05)^52)

Price of bond = $44.57 * ((1 - 0.0791) / 0.05) + ($1,000 * 0.0791)

Price of bond = ($44.57 * 18.418) + $79.10

Price of bond = $820.90 + $79.10

Price of bond = $900

b) Market value of bond = No. Of bonds * Price of bond

Market value of bond = 20,000 bonds * $900

Market value of bond = $1,80,00,000

h) Value of D/V = Debt / Value of corp

Here, Value of Corp = Debt + Stock

Value of Corp = $1,80,00,000 + $30,000

Value of Corp = $1,80,30,000

Now,

Value of D/V = $1,80,00,000 / $1,80,30,000

Value of D/V = 0.9983 or 99.83%

i) WACC = (Weight of debt * Cost of debt) + (Weight of equity * Cost of equity)

Here, Weight of debt (refer h) = 0.9983

Weight of equity = 1 - 0.9983 = 0.0017

Cost of debt (refer a) = 0.0750

Cost of equity (refer f) = 0.2480

Now,

WACC = (0.9983 * 0.0750) + (0.0017 * 0.2480)

WACC = 0.0749 + 0.0004

WACC = 0.0753 or 7.53%