Question

A firm is finance by a short term bank loan, long term corpoatte binds and equity. The market value of the bank loan is 140,200 and the interest rate paid on it is 6.25%. The market value of corporate bonds is $305,300 and the interest rate paid on them is 8.25%. The expected rate of return on the companys share is 15.25%. There are 70,000 shares outstandig, and the shares are trading at $5. The corporate tax rate is 30% and there are no other taxes.

1. Calculate the value of equity and the total value of the firm

2. Calculate the companys weighted average cost of capital.

Answer 1

1. Calculate the value of equity and the total value of the firm

Equity value = P x N = $ 5 x 70,000 = $ 350,000

Value of the firm = Equity value + value of the debt = 350,000 + (140,200 + 305,300) = $ 795,500

2. Calculate the company's weighted average cost of capital.

Please see the table below. Please be guided by the second row to understand the mathematics. The cell highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $.

Element	Value	Proportion	Pre tax cost	Tax rate	Post tax cost	Component cost
		A	B	C	D = B x (1 - C)	A x D
Bank loan	140,200	17.62%	6.25%	30.00%	4.38%	0.77%
Corporate bonds	305,300	38.38%	8.25%	30.00%	5.78%	2.22%
Equity	350,000	44.00%	15.25%	NA	15.25%	6.71%
Total	795,500	100.00%				9.70%

Hence, the company's weighted average cost of capital = 9.70%