Question

In: Finance

Consider the following information: 1) Bonds outstanding: 80,000. Each bond sells at its $1,000 par value....

Consider the following information:

1) Bonds outstanding: 80,000. Each bond sells at its $1,000 par value. The bonds are priced to provide a YTM of 8.6 percent.

2) Stock outstanding: 4 million shares. Current stock price = $40 per share. Book value = $28 per share. Current stock beta = 1.1.

3) The risk-free rate is 4%, the tax rate is 34%, and the expected return on the market portfolio is 12%.

What is the weighted average cost of capital (WACC)?

Solutions

Expert Solution

YTM of Bond = 8.6%.

Post Tax YtM of The Bond = YTM x (1-Tax Rate)

Post Tax YtM of The Bond = 8.6% (1-0.34) = 5.676%

Market Value of each bond = $ 1000

Total Market Value of Bond issued = No. of Bonds x Market Value of Bond = 80000 x 1000 = 80000000‬

No. of Shares = 4 Million Shares

Current Stock Price = $ 40

Now, Market Value of Equity = 40 * 4 Million Shares = 160000000‬.

Now, WACC = Wighted average cost of Capital = Weights of Debt x Post Tax YTM + Weight of Equity x Required Rate of Return

where weights are based on Market value of Debt and equity

Weight of Debt = Market Value of Debt/ Market Value of Debt + Equity

Weight of Equity = 1 - Weight of Debt

Weight of Debt = 80000000‬/160000000‬+80000000‬

Weight of Debt = 0.33

Weight of Equity = 0.67

Now According to CAPM Required Rate of Retrun of Stock = Risk Free Rate of Retrun + (Expected Return on Market - Risk Free Rate of Retrun) x Beta of Stock

According to CAPM Required Rate of Retrun of Stock = 4% + (12% - 4%) x1.1 = 12.8%

Now, WACC = 5.676% x 0.33 + 0.67 x 12.8% = 10.45%


Related Solutions

The Johnson Corporation sells 1,000 bonds; each bond has a face (par) valueof $1,000. The Bonds...
The Johnson Corporation sells 1,000 bonds; each bond has a face (par) valueof $1,000. The Bonds are sold on January 1, 2010. The face interest rate of each bond is 4.5%, with interest being paid twice per year, July 1st and January 1st. The bonds are 5-year bonds. The market interest rate (yield) for these types of bonds (securities) at the time the bonds are sold (January 1, 2010) is 4% annually. Requirements: a. What is the total amount of...
An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and...
An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and a 10% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 5%. What is the percentage change in price for each bond after the decline in interest rates? (Round all the answers below to two decimal places) Price 10% Price 5%    Percentage Change 10-year, 10% annual coupon 10-year...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and a 8% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 7%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Enter all amounts as positive numbers. Do not round intermediate calculations. Round your monetary answers to...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and a 9% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 5%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Enter all amounts as positive numbers. Do not round intermediate calculations. Round your monetary answers to...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and an 8% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 6%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Enter all amounts as positive numbers. Do not round intermediate calculations. Round your monetary answers to...
An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and...
An investor purchased the following 5 bonds. Each bond had a par value of $1,000 and an 8% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 6%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Round your answers to the nearest cent or to two decimal places. Enter all amounts as...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and...
An investor purchased the following five bonds. Each bond had a par value of $1,000 and a 11% yield to maturity on the purchase day. Immediately after the investor purchased them, interest rates fell, and each then had a new YTM of 5%. What is the percentage change in price for each bond after the decline in interest rates? Fill in the following table. Enter all amounts as positive numbers. Do not round intermediate calculations. Round your monetary answers to...
Consider the following information regarding a convertible bond: Par value = $1,000 Conversion ratio = 30:1
Consider the following information regarding a convertible bond: Par value = $1,000 Conversion ratio = 30:1 Convertible bond price = $1,020 Given that the conversion premium is $30, the current share price is closest to: A. $30.00. B. $32.33. C. $33.00.Consider the following information regarding a convertible bond: Par value = $1,000 Conversion ratio = 30:1 Convertible bond price = $1,020 Given that the conversion premium is $30, the current share price is closest to: A. $30.00. B. $32.33. C. $33.00.
8-Marriot Corporation has two bond issues outstanding, each with a par value of $1,000. Information about...
8-Marriot Corporation has two bond issues outstanding, each with a par value of $1,000. Information about each is listed below. Suppose market interest rates rise 1 percentage point across the yield curve. What will be the change in price for each of the bonds? Does this tell us anything about the relationship between coupon rate and interest rate risk? Bond A: 10 years to maturity, 0 percent coupon, market interest rate is 9.62 percent. Bond B: 10 years to maturity,...
Midland Utilities has a bond issue outstanding that will mature to its $1,000 par value in...
Midland Utilities has a bond issue outstanding that will mature to its $1,000 par value in 19 years. The bond has a coupon interest rate of 11​% and pays interest annually. a. Find the value of the bond if the required return is​ (1) 11​%, ​(2) 15​%, and​ (3) 8​%. b. Use your finding in part a and the graph​ here, to discuss the relationship between the coupon interest rate on a bond and the required return and the market...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT