Question

Bud light has a capital structure that consists of 250,000 semi-annual coupon bonds each with a par value of $1000. These bonds have a maturity of 20 years, a coupon rate of 8% per year, and are currently selling at 105 percent of par. Bud also has 9 million shares of common stock outstanding with a share price of $40 per share. The shares have a beta of 1.50. T- bills have a yield of 3.5%, the market risk premium is 7% and the tax rate is 24%.

1. What is the firm’s market value capital structure?

2. If the company is evaluating a new investment project that has the same risk as the firm’s

   typical project, what rate should the firm use to discount the project’s cash flows?

Answer 1

Firms Market capital structure :-

Particulars	no. of bonds / shares outstanding	market value per bond/ share	Market value	Weights (market value / total value)
Debt	250,000 bonds	1050	262,500,000.00	0.4217
Equity	9,000,000 shares	40	360,000,000.00	0.5783
total	622,500,000.00	1.00

Calculation of the Discount rate :-

Cost of debt before tax =[ i + ( D - NP) / n ] / ( D + NP)/2

Here I = annual interest payment =1000 * 8% = 80

D = Face value =1,000

NP = Net proceeds =1000 * 105% = 1050

n= 20

= [80 + (1000 - 1050) / 20 ] / ( 1000+1050) / 2

= [ 80 -2.5] / 1025

cost of debt before tax = 0.0756098

cost of debt after tax = 0.0756098 * (1 - 0.24) = 5.746%

cost of equity = Rf + Beta * market risk premium

= 3.5% + 1.50 * 7%

cost of equity = 14%

Normarlly WACC is used for discounting rate.

WACC = Cost of debt after tax * weight of debt + cost of equity * weight of equity

= 5.746% * 0.4217 + 14% * 0.5783

WACC = 10.5193%

discount rate = 10.5193%