Question

Prompt: After reviewing the data in the table, respond to the problems below. Indicate the answer you believe is correct.

Zonk Corporation Data

Total assets	$7,460
Interest-bearing debt	$3,652
Average pretax borrowing cost	10.5%
Common equity:
Book value	$2,950
Market value	$13,685
Income tax rate	35%
Market equity beta	1.13

Question 1: Assuming that the riskless rate is 2.3% and the market premium is 5.3%, calculate Zonk’s cost of equity capital:

A. 10.4%

B. 7.69%

C. 11.89%

D. 8.28%

Question 2: Determine the weight on debt capital that should be used to calculate Zonk’s weighted-average cost of capital:

A. 21.7%

B. 21%

C. 50%

D. 58.2%

Question 3: Determine the weight on equity capital that should be used to calculate Zonk’s weighted-average cost of capital:

A. 79%

B. 78.3%

C. 41.8%

D. 50%

Question 4: Using the above information, calculate Zonk’s weighted-average cost of capital:

A. 11.5%

B. 7.97%

C. 7.48%

D. 10.90%

Question 5: Assume that Zonk is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity. Compute the revised equity beta for Zonk based on the new capital structure.

A. 4.35

B. 4.34

C. 2.84

D. 3.91

Question 6: Assume that Zonk is a potential leveraged buyout candidate. Assume that the buyer intends to put in place a capital structure that has 70 percent debt with a pretax borrowing cost of 14 percent and 30 percent common equity. Compute the weighted average cost of capital for Zonk based on the new capital structure.

A. 8.85%

B. 12.56%

C. 13.01%

D. 9.94%

Answer 1

As per policy, only four parts of a question are allowed to answer at a time, so answering first 4 questions to problem :

Answer to Problem :

1) Formula : Ce = rf + B * Mp
Ce = 0.023 + 1.13 * 0.053 = 0.0828 or 8.28% (option D)
2) Total Market value of firm = MV of debt + MV of equity
Total Market value of firm = 3652 + 13685 = 17337
Weight on debt capital = MV of debt / total MV of firm = 3652/17337=21% (option B)
3) Total Market value of firm = MV of debt + MV of equity
Total Market value of firm = 3652 + 13685 = 17337
Weight on equity capital = MV of equity / total MV of firm = 13685/17337=79% (option A)
4) WACC = Wd * Cd * (1-Tax) + We * Ce = 0.21 * 0.105 * (1-0.35) + 0.79 * 0.0828 = 0.0797 or 7.975 (option B)