Question

Please provide specific Excel functions =NPV(…), =IRR(…), =AVERAGE(…), =YIELD(…) etc......

Given the following information for Bajor Co.:

Debt: Bajor’s long-term debt capital consists of bonds with 6.250 percent coupon rate (semiannual coupon payments), 9 years time-to-maturity, and current price of 106.61 percent of its par value (i.e., price = 106.61 relative to full amount redemption par of 100).

Preferred stock: Bajor has not issued any preferred stocks.

Common stock (equity):

• Bajor’s equity capital consists of common stocks with the most recent annual dividend of $0.92 per share, and a current stock price of $14 per share.
• According to online data sources, Bajor’s long-term dividend growth (for next 5-Year average, per annum) g = 4.5% per year.
• The “risk-free” Treasury bill return is 3.8%; the market expected return for the stock market on average is 12.3%; and Bajor’s systematic risk (Beta) is 0.71.

Taxes: The applicable federal-plus-state corporate tax rate for Bajor is 25.7 percent.

Capital weight: Bajor’s “Market Cap” amounts to $18.23 billion, and “Total Debt” amounts to $14.44 billion. You can use such data to estimate the capital weights for equity and debt, respectively (We and Wd).

Time constraint: For any investment projects, Bajor are required by her investors to recover its initial cost within no more than 6 years.

Q1: What is Bajor’s pretax cost of debt Rd, cost of equity Re, and WACC, respectively? (Hint: For the best estimate of cost of equity Re, you must apply both CAPM and Dividend Growth Model and then average the two estimates.)      

Answer 1

1:

Using financial calculator

Input: FV= 100

PMT = 6.25%*100/2 = 3.125

N = 9*2 = 18

PV = -106.61

Solve for I/Y as 2.66

Pre tax cost of debt = 2.66%*2 = 5.32%

After tax cost of debt = 5.32%*(1-25.7%)

= 3.95%

2: cost of equity as per CAPM= risk-free rate + Beta*(market return-risk-free rate)

= 3.8%+0.71*(12.3%-3.8%)

=0.09835

Cost of equity as per dividend discount model= expected dividend/current price+ growth rate

= 0.92*104.5%/ 14 + 4.5%

=0.113671

Average cost of equity= (0.09835+ 0.113671)/2 = 10.6%

3: weighted average cost of capital= after-tax cost of debt* market value of debt/total value + average cost of equity* market cap/total value

=3.95%*14.44/(14.44+18.23) + 10.6%*18.23/(14.44+18.23)

=7.66%

WORKINGS