Question

Company x AB has 10 million shares of equity outstanding. The current share price is 50 SEK, and the book value per share is 5 SEK.

The company also has two bond issues outstanding. The first bond issue has a face value of 100Million SEK (MSEK) and a 10 per cent annual coupon payment , sells for 90 per cent of par (face value of 1,000SEK), and matures in 1 year.

The second issue has a face value of £60 million and a 7.5 per cent annual coupon payment and sells for 96.5 per cent of par. The first issue matures in 10 years, the second in 6 years.

Note that in both bonds, there will be one coupon payment and face value.

Suppose the company’s equity has a beta of 2. The risk-free rate is 6 per cent, and the expected return on the market is 16 per cent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semi-annual payments. The tax rate is 35 per cent.

Calculate:

1. Return of Equity
2. YTM of each bond
3. The weighted average after-tax cost of debt
4. Company’s WACC?

Answer 1

1]	Cost of equity per CAPM = 6%+2*(16%-6%) =	26.00%
2]	Cost of the first bond:
	Before tax cost of debt = YTM.
	YTM using a financial calculator = 11.75%
	[Inputs: Current price 900; Coupon 10%,
	# years 10, frequency of payment - 1]
	After tax cost of first bond = 11.75%*(1-35%) =	7.64%
3]	Cost of second bond:
	YTM using a financial calculator = 8.26%
	[Inputs: Current price 865; Coupon 7.5%,
	# years 6, frequency of payment - 1]
	After tax cost of second bond = 8.26%*(1-35%) =	5.37%
4]	CALCULATION OF WACC:
	Source of capital	Market Value [$ millions]	Weight	Component cost	WACC
	First bond [100*90%]	90.00	13.89%	7.64%	1.06%
	Second bond [60*96.5%]	57.90	8.94%	5.37%	0.48%
	Equity [10*50]	500.00	77.17%	26.00%	20.06%
	Total	647.90	100.00%		21.61%
	WACC =	21.61%