In: Finance
WACC Estimation
On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $20 million in new projects. The firm's present market value capital structure, here below, is considered to be optimal. There is no short-term debt.
Debt | $30,000,000 |
Common equity | 30,000,000 |
Total capital | $60,000,000 |
New bonds will have a 6% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 = 4%.) The marginal tax rate is 25%.
$
%
I. rs will decrease and the WACC
will increase due to the flotation costs of new equity.
II. rs and the WACC will not be
affected by flotation costs of new equity.
III. rs and the WACC will increase due
to the flotation costs of new equity.
IV. rs and the WACC will decrease due
to the flotation costs of new equity.
V. rs will increase and the WACC will
decrease due to the flotation costs of new equity.
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Answer:
a
.Required Investments = $30,000,000
Since the total market value of the firm is $60,000,000
Out of that, $30,000,000 is financed through equity, then the
weight of equity = $30,000,000 / $60,000,000
= 0.5
Common equity needed = Total Amount of Investment × Weight of
Equity
= 0.5($20,000,000)
= $10,000,000.
b.
Cost of Equity =
=
= 0.12
= 12%
After Tax Cost of Debt = Before Tax Cost of Debt × (1-Tax
Rate)
= 6 × (1-0.25)
= 4.5%
WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt ×
After Tax Cost of Debt)
= (0.5 × 12%) + (0.5 × 4.5%)
= 8.25%
c)
Option III