Question

Ohio Inc. has a global beta of 1.6 and its​ debt-to-equity ratio is 0.6. The​ risk-free rate is​ 3.2% and the expected global market risk premium is​ 9%. Although Ohio is a US​ firm, it issued Swiss Franc​ (SF) denominated bond and converted SF to US dollar. The​ semi-annual interest payment is made in SF. The coupon rate is​ 8%, the price of the bond is​ SF1020, the face value is​ SF1,000, and the bond matures in 15 years. The exchange rate is expected to move from​ SF0.9400/$ to​ SF0.9200/$. ​ Ohio’s tax rate is​ 40%.

a.​ What’s Ohio’s SF cost of​ debt? ​____________________

b.​ What’s your best estimate of​ Ohio’s US dollar cost of​ debt? ​______

c.​ What’s Ohio’s cost of​ equity? ​____​______________

d.​ What’s Ohio’s​ WACC? ​___________________

Answer 1

Answer-

a) Ohio’s SF cost of​ debt

Given

Face value = FV = SF 1000
Present value = PV = SF 1020
Coupon rate = 8 %
Couon rate semi annual payment = 8 % / 2 = 4 %
Coupon payment = SF 40 [ 4 % x SF 1000 = SF 40 ]
Maturity in years = 15 years
Number of periods = 15 x 2 = 30 years [ semi annual payment ]

YTM = I/Y = cost of debt =  3.886 % / semiannual
YTM = I/Y = cost of debt =   3.886 x 2 = 7.772 %

Therefore Ohio’s SF cost of​ debt = 7.772  %

b)

best estimate of​ Ohio’s US dollar cost of​ debt

The value of exchange rate moves from SF 0.94 / $ to SF 0.92 / $

Present value = SF 1020 = 1020 / 0.94 = $ 1085.11

Face value = SF 1000 = 1000 / 0.92 = $ 1086.96  

Coupon payment = 4 % x $ 1086.96  = $ 43.48
Number of periods = 30

YTM = I/Y = cost of debt = 4  % / Semi annual

$ cost of debt = 4 % x 2 = 8 %

c)

Ohio’s cost of​ equity

beta = 1.6
risk-free rate = 3.2%
market risk premium = 9%

Cost of equity = risk free rate + Beta x market risk premium

Cost of equity = 3.2 % + 1.6 x 9 %
Cost of equity = 3.2 % + 14.4 %

Cost of equity = 17.6 %

d)

Ohio’s​ WACC

WACC = Wt of equity x Cost of equity + Wt of debt x Cost of debt x ( 1 - tax rate )

Given

Debt / Equity = 0.6 / 1
Debt / total capital = 0.6 / (0.6 +1) = 0.6 / 1.6 = 0.375
Equity / total capital = 1 / 1.6 = 0.625

tax rate = 40 % = 0.40
1- tax rate = 1 - 40 % = 1 - 0.40 = 0.60

Substituting the above values we get

WACC = 0.625 x 17.6 % + 0.375 x 8 % x 0.60
WACC = 11 % + 1.8 %

WACC = 12.8 %