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Use the information below to determine the security prices and cost of capital for the ABC...

Use the information below to determine the security prices and cost of capital for the ABC Inc that uses the following capital structure.

Debt: the firm has 43,094 bonds which have 15 years to maturity, pay an annual coupon of 12% and have a face value of $1000. The current YTM on comparable bonds is 9%.

Equity: the firm has 1,000,000 shares of common stock, which is expected to pay a dividend per share of $1.00 in year 1, a dividend per share of $2.00 in year 2, and a dividend of $3.00 in year 3. After year 3, dividends are expected to grow at the rate of 3% per year indefinitely. The market risk premium (rm-rf) is 7% and the risk free rate is 3%. The firm’s equity beta is 1.5. The relevant tax rate is 30%

What is the market value of the firm’ bonds and stock, and its total market value?

What is the firm’s WACC (Weighted Average Cost of Capital)?

Solutions

Expert Solution

Lets calculate the market value of the debt:

C= 12% of 1000 = 120

YTM = 9%

n =15

P= 1000

Using excel and above formula to calculate the values:

Summation for the 15 years = 967.283

Discounted Principal = 274.538

So total return from the bond = 1241.821

Market Value of Debt = 1241.821 * 43094 =  53515019.22

Now lets calculate the MV of equity:

Using CAPM , 3% + 1.5*7% = 13.5% = 0.135

So equity price (as dividends are 1,2,3 for the first three years respectively, and then a growth of 3% indefnitely)

Dividend after 3 years = 3 +0.03*3 = 3.09

1/ (1+ 0.135) + 2/ (1+0.135)^2 +3 / (1+0.135)^3 + 3.09 / ((0.135-0.03) (1+0.135)^3) = 24.61

MV of Equity = 24.61 * 1,000,000 = 24610000

Total MV = 24610000 + 53515019.22 = 78125019.22

(B) Weight of Equity = 0. 3150

Weight of debt = 0.6849

Tax = 30%

WACC = (Cost of Equity * Wt. of Equity) + (Cost of Debt*Wt. of debt*(1-Tax rate))

13.5% * 0.315 + 9% * 0.6849*(1-0.3 ) = 8.5674%

## please upvote if the answer helps

jeff jeffy answered 1 year ago
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