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Tere company has 4.3 million shares of common stock outstanding and 85,000 bonds outstanding, par value...

Tere company has 4.3 million shares of common stock outstanding and 85,000 bonds outstanding, par value of $1,000 each. Each bond has a 6.8 percent annual coupon rate and the bonds have 23 years to maturity and is now selling at $789.23. (Based on the current price, its YTM is 9%) Coupon is paid annually. The common stock currently sells for $58.00 per share and has a beta of 0.90. The market risk premium is 7 percent and Treasury bills are yielding 5 percent and the company’s tax rate is 35 percent.

a. What are the weight of debt component (D/V) in the firm’s capital structure? (Round up your answer to the nearest two decimal)

b. What is the weight of equity component (E/V) in the firm’s capital structure? (Round up your answer to the nearest two decimal points)

c.If the company is evaluating a new investment project that has the same risk as the firm’s typical project, what rate should the firm use to discount the project’s cash flows

Solutions

Expert Solution

Calculation of the weights of debt & equity based on market values:-

Particulars Amount
Market value of bonds 85,000 bonds * $ 789.23 $ 67,084,550
Market value of equity 4,300,000 * $ 58 $ 249,400,000
Total value of firm $ 316,484,550

a) weight of debt :-

Weight of debt = market value of debt / total value of firm = $ 67,084,550 / 316,484,550 = 0.21296785

Weight of debt = 0.21

B) weight of equity:-

Weight of equity = 249,400,000 / 316,484,550 = 0.788032149

Weight of equity = 0.79

C) calculation of discounting rate :-

The best discount rate to evaluvate the project is at WACC rate.

calculation of WACC:-

cost of debt after tax = YTM * ( 1 - tax rate) = 9% * ( 1 - 0.35)

Cost of debt after tax = 5.85%

Cost of equity = Rf + beta * market risk premium

= 5% + 0.90 * 7%

Cost of equity = 11.3%

WACC = weight of debt * cost of debt after tax + weight of equity * cost of eauity

= 0.21 * 5.85% + 0.79 * 11.3%

WACC = 10.1555%

Discount rate = WACC = 10.1555%

jeff jeffy answered 1 year ago
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