XYZ is a company that does business in Brisbane. XYZ has 1 million semi-annual coupon bonds...

XYZ is a company that does business in Brisbane. XYZ has 1 million semi-annual coupon bonds with a face value of $1000 each. At present, its bonds trade at 110% of par. The yield to maturity of the bonds is quoted at 7.5% per annum. The bonds have a coupon rate of 8.0% per annum and 15 years to maturity. The company has 150 million ordinary shares outstanding and a beta of 1.30. It currently trades at $25 per share. The market risk premium is 9.0% per annum and the risk-free rate is 4.0% per annum. XYZ is subject to 35% corporate tax rate. XYZ is planning to produce a new line of green products for Brisbane’s market. Before deciding on whether to go ahead with this potential project, the company has hired you to estimate the weighted average cost of capital (WACC) in order to evaluate the NPV analysis of this project. (a) What is the cost of equity for company XYZ? (b) What is the cost of debt for XYZ? What is the after tax WACC for XYZ? (c) What is the after tax WACC for XYZ?

Expert Solution

(a)	Cost of Equity:
	CAPM EQUATION:Rs=Required Return of stock
	Rs=Rf+Beta*(Rm-Rf)
	Rf=riskfree rate=4%, Rm-Rf=Market risk Premium=9%, Beta=1.30
	Rs=4+1.3*9=	15.70%
Ce	Cost of Equity =	15.70%
b)	Cost of Debt
	Yield To Maturity	7.50%
Cd	After Tax Cost of debt =7.5(1-Tax Rate)=7.5(1-0.35)=	4.88%

c	WACC(Weighted Average Cost of Capital)

	MARKET VALUE OF THE FIRM'S CAPITALSTRUCTURE
	Debt
	Market Price of each bond=110%*1000=	$1,100
	Number of Bonds outstanding	1	million
	Total Market value of bonds=1100*1million=	$1,100	million
	Market Price of each share of common stock	$25
	Number of shares of common stock outstanding	150	million
	Total Market value of Common stock=$25*150million=	$3,750	million
a	Total Market value of bonds	$1,100	million
b	Total Market value of Common stock	$3,750	million
c	Market Value of Debt+Equity	$4,850
Wd=a/c	Weight of Debt in the capital structure	0.23
We=b/d	Weight of Common Shares in the capital structure	0.77
	Weighted Average Cost of Capital (WACC)
	WACC=WdCd+WeCe=0.234.88%+0.7715.70%	13.24%
	Wd=Weight of Debt in the total capital
	We=Weight of Equity in the total capital
	Cd=Cost of debt
	Ce=Cost of Equity
	AFTER TAX WACC	13.24%

jeff jeffy answered 1 year ago

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