Question

In: Finance

Below you are given information on Efaw, Inc.’s capital structure as well as information on Efaw’s...

  1. Below you are given information on Efaw, Inc.’s capital structure as well as information on Efaw’s stock and bonds. Compute Efaw’s cost of capital.

Capital Structure

Book Value of Debt

$2,000,000,000

Market Value of Debt

$2,500,000,000

Book Value of Equity

$3,500,000,000

Market Value of Equity

$4,000,000,000

Stock Info

Beta

                  1.32

Risk free rate

1.25%

Market risk premium

7.50%

Cost of issuing equity

5%

Bond Info

Coupon rate

6%

Years to mat;urity

22

Par value

$1,000

Price of bond

$963.75

Cost of issuing debt

2.50%

Solutions

Expert Solution

Debt:
Par Value = $1,000

Current Price = $963.75 - 2.50% * $963.75
Current Price = $939.65625

Annual Coupon Rate = 6.00%
Annual Coupon = 6.00% * $1,000
Annual Coupon = $60

Time to Maturity = 22 years

Let Annual YTM be i%

$939.65625 = $60 * PVIFA(i%, 22) + $1,000 * PVIF(i%, 22)

Using financial calculator:
N = 22
PV = -939.65625
PMT = 60
FV = 1000

I = 2.5505%

Annual YTM = 6.524%

Cost of Debt = 6.524%

Equity:
Cost of Equity = Risk-free Rate + Beta * Market Risk Premium
Cost of Equity = 1.25% + 1.32 * 7.50%
Cost of Equity = 11.15%

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $2,500,000,000 + $4,000,000,000
Market Value of Firm = $6,500,000,000

Weight of Debt = $2,500,000,000 / $6,500,000,000
Weight of Debt = 0.3846

Weight of Equity = $4,000,000,000/ $6,500,000,000
Weight of Common Stock = 0.6154

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Common Stock * Cost of Common Stock
WACC = (0.3846 * 6.524%) + (0.6154 * 11.15%)
WACC = 9.37%

jeff jeffy answered 2 years ago
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