Question

the Stanley company sold a $1000 par value, noncallable bond several years ago that now has 10 years to maturity and a 8.00% annual coupon that is paid semiannually. the bond currently sells for $922 and the tax rate is 30%. What is the component cost of debt for use in the WACC calculation? a. 6.28% b. 5.46% c. 5.65% d. 6.45% e. 7.03%

Farmington Enterprises stock trades for $42.50 per share. It is expected to pay a $2.50 dividend at year end, and the dividend is expected to grow at a constant rate of 6% a year. What is the company's cost of common equity from reinvesting earnings? a. 11.54% b. 11.65% c. 11.88% d. 12.13% e. 12.35%

Refer to the data for Farmington Enterprise in Question 2. The before-tax cost of debt is 7.50%, and the tax is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company's WACC if all the equity used is from reinvested earnings? a. 7.43% b. 7.55% c. 7.89% d. 8.48% e. 8.56%

Answer 1

Answer to Question 1.:

Face Value = $1,000
Current Price = $922

Annual Coupon Rate = 8.00%
Semiannual Coupon Rate = 4.00%
Semiannual Coupon = 4.00% * $1,000 = $40

Time to Maturity = 10 years
Semiannual Period to Maturity = 20

Let semiannual YTM be i%

$922 = $40 * PVIFA(i%, 20) + $1,000 * PVIF(i%, 20)

Using financial calculator:
N = 20
PV = -922
PMT = 40
FV = 1000

I = 4.61%

Semiannual YTM = 4.61%
Annual YTM = 2 * 4.61%
Annual YTM = 9.22%

Before-tax Cost of Debt = 9.22%
After-tax Cost of Debt = 9.22% * (1 - 0.30)
After-tax Cost of Debt = 6.45%

Option d is Correct.

Answer to Question 2.:

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $2.50 / $42.50 + 0.06
Cost of Equity = 0.0588 + 0.06
Cost of Equity = 0.1188 or 11.88%

Option c is Correct.

Answer to Question 3.:

Before-tax Cost of Debt = 7.50%
After-tax Cost of Debt = 7.50% * (1 - 0.40)
After-tax Cost of Debt = 4.50%

WACC = (Weight of Debt * After Tax Cost of Debt) + (Weight of Equity * Cost of Equity)
WACC = (0.45 * 0.0450) + (0.55 * 0.1188)
WACC = 0.02025 + 0.06534
WACC = 0.08559
or WACC = 8.56%

Option e is Correct