Question
In: Finance
Below you are given information on Efaw, Inc.’s capital structure as well as information on Efaw’s...
- 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%
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