Question

1. Company XYZ has 8.3 million shares outstanding. The current share price is $53, and the book value per share is $4. XYZ has two bonds outstanding.

1. Bond 1 has a face value of $70 million and a 7 percent Coupon rate and sells for 108.3% of par.
2. Bond 2 has a face value of $60 million and 7.5% coupon rate and sells for 108.9% of par.

Bond 1 matures in 8 years, Bond 2 matures in 27 years. All coupon payments are semi-annual.

1. Find the company’s capital structure weights on a market value basis. Find the Capital structure weights on a book value basis.

(Book value of the debt = Face Value and the market value of the debt price quote times the face value)

1. Suppose the company has a beta of 1.2, the risk free rate is 3.1percent, and the market risk premium is 7%. What is the WACC? Assume that the tax rate is 35%.

Answer 1

Solution:

Calculation of WACC:

a)Calculation of cost of equity(Ke)as per CAPM

Ke=Risk free rate+Beta*Market risk premium

=3.10%+1.2*7%

=11.50%

b)After tax cost of Bond 1(Kd1)

Let the face value of each bond is $100

Cost of debt=[Annual coupon+(Face Value-Sale Price)/years to maturity]/(Face Value+Sale Price)/2

=[$7+($100-$108.90)/8]/($100+$108.90)/2

=0.0564 or 5.64%

After tax cost of debt=Cost of debt(1-tax rate)

=5.64%(1-0.35)=3.66%

c)After tax cost of Bond 2(Kd2) using above formula

Cost of debt=[$7.5+($100-$108.90)/27]/($100+$108.90)/2

=0.0639 or 6.39%

After tax cost of debt=6.39%(1-0.35)

=4.15%

d)Calculation of total market value of capital

Total Market value=Market value of equity+Market value of Debt1+Market value of debt2

=(8300,000*$53)+($70,000,000*108.3%)+($60,000,000*108.9%)

=439900,000+75810,000+$65340,000

=$581,050,000

e)Calculation of Weight of Each source of capital

Weight of Equity(We)=Market value of equity/Total Market value

=439900,000/$581,050,000

=0.76

Weight of bond 1(Wd1)=75810,000/$581,050,000

=0.13

Wight of Bond2(Wd2)=$65340,000/$581,050,000

=0.11

f)Calculation of WACC

WACC=Ke*We+Kd1*Wd1+Kd2*Wd2

=11.50%*0.76+3.66%*0.13+4.15%*0.11

=9.67%