Question

NOTE PLEASE I NEED ALL THE SUBPARTS WITH DETAILS***

Janet Adams, CFA, is reviewing Rival Company’s financial statements. Rival’s long-term debt total $35 million, while total shareholder equity equals $140 million. Rival’s long-term debt has a YTM of 9%. Rival’s tax rate is 40% and its beta is 0.9. Adams gathers the following additional facts:

• Treasury bills earn 4.0%.

• The risk premium of the stock is 4.05%.

19. Based on the information provided, Rival’s after-tax cost of debt is closest to: *

A. 9%

B. 5.4%

C. 3.6%

D. 40%

E. None of the above

20. Based on the information provided, Rival’s cost of equity is closest to: *

A. 8.05%

B. 4.05%

C. 7.65%

D. 7.64%

E. None of the above

21. Based on the information provided, Rival’s weighted average cost of capital is closest to: *

A. 4.6%

B. 7.5%

C. 8.2%

D. 7.2%

E. None of the above

Answer 1

Answer to Question 19:

Before-tax Cost of Debt = Yield to Maturity
Before-tax Cost of Debt = 9.00%

After-tax Cost of Debt = Before-tax Cost of Debt * (1 - Tax Rate)
After-tax Cost of Debt = 9.00% * (1 - 0.40)
After-tax Cost of Debt = 5.40%

Answer to Question 20:

Cost of Equity = Risk Premium + Risk-free Rate
Cost of Equity = 4.05% + 4.00%
Cost of Equity = 8.05%

Answer to Question 21:

Market Value of Firm = Market Value of Debt + Market Value of Equity
Market Value of Firm = $35 million + $140 million
Market Value of Firm = $175 million

Weight of Debt = Market Value of Debt / Market Value of Firm
Weight of Debt = $35 million / $175 million
Weight of Debt = 0.20

Weight of Equity = Market Value of Equity / Market Value of Firm
Weight of Equity = $140 million / $175 million
Weight of Equity = 0.80

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Equity * Cost of Equity
WACC = 0.20 * 5.40% + 0.80 * 8.05%
WACC = 7.52% or 7.5%