Question
In: Finance
Below you are given information on Axelrod Enterprises’s capital structure as well as information on Axelrod’s...
- Below you are given information on Axelrod Enterprises’s capital structure as well as information on Axelrod’s stock and bonds. Compute Axelrod’s cost of capital.
|
Capital Structure |
|
|
Book Value of Debt |
$2,500,000,000 |
|
Market Value of Debt |
$2,250,000,000 |
|
Book Value of Equity |
$3,100,000,000 |
|
Market Value of Equity |
$4,200,000,000 |
|
Stock Info |
|
|
Beta |
0.95 |
|
Risk free rate |
0.85% |
|
Market risk premium |
8.00% |
|
Bond Info |
|
|
Coupon rate |
5% |
|
Years to mat;urity |
18 |
|
Par value |
$1,000 |
|
Price of bond |
$1,265.25 |
Solutions
Expert Solution
Debt:
Face Value = $1,000
Current Price = $1,265.25
Annual Coupon Rate = 5.00%
Annual Coupon = 5.00% * $1,000
Annual Coupon = $50
Time to Maturity = 18 years
Let Annual YTM be i%
$1,265.25 = $50 * PVIFA(i%, 18) + $1,000 * PVIF(i%, 18)
Using financial calculator:
N = 18
PV = -1265.25
PMT = 50
FV = 1000
I = 3.061%
Annual YTM = 3.061%
Cost of Debt = 3.061%
Equity:
Cost of Equity = Risk-free Rate + Beta * Market Risk
Premium
Cost of Equity = 0.85% + 0.95 * 8.00%
Cost of Equity = 8.450%
Market Value of Firm = Market Value of Debt + Market Value of
Equity
Market Value of Firm = $2,250,000,000 + $4,200,000,000
Market Value of Firm = $6,450,000,000
Weight of Debt = $2,250,000,000 / $6,450,000,000
Weight of Debt = 0.3488
Weight of Equity = $4,200,000,000 / $6,450,000,000
Weight of Equity = 0.6512
WACC = Weight of Debt * Cost of Debt + Weight of Equity * Cost
of Equity
WACC = 0.3488 * 3.061% + 0.6512 * 8.450%
WACC = 6.57%
Therefore, cost of capital for Axelrod is 6.57%
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