American Steel has issued $50 million in long-term bonds, with a face value of $1,000 paying...

American Steel has issued $50 million in long-term bonds, with a face value of $1,000 paying a 9% coupon. The bonds are now trading at a 15% premium to their face value providing a yield-to-maturity of 7%. The firm also has 1.5 million shares of common stock that were issued at $43/share at the company’s IPO and are currently trading at $56/share. American Steel is a mature firm that paid a $7 dividend last year, and dividends are expected to grow at 2% indefinitely. American Steel also has 500,000 preferred shares issued that are trading at $10/share with a dividend of $1. Treasury bills are currently yielding 5%, the firm has a Beta of 1.1, and its tax rate is 35%. Please show your answer to one decimal place.

i) What is the value of the firm?

ii)What is the market value of the firm’s debt and equity (common/pref)?

iii) What is the firm’s weighted average cost of capital?

Solutions

Expert Solution

Given

Face value =$1000

Premium value =$1000 + 15% of 1000= $1150

Coupon rete = 9%

Yield to maturity or Cost of Debt =7%

Market value of Equity = No.of shares * Currently trading price = 1.5million *56= $84 million.

Market value of preferred shares= 500,000 * 10= $500,0000.

Market value of debt =$50 million * 1150= $57500 million

Treasury bills or Risk Free rate= 5%

Beta= 1.1

Tax rate= 35%

A) Value of firm or Enterprise Value(EV)= Market capitalization + Preferred stock + Outstanding debt + Minority interest – Cash and cash equivalents

EV= $84million + $500,0000 + $50million +57500 million-0 = $57369,000,000.

B) Market value of Equity = No.of shares * Currently trading price = 1.5million *56= $84 million.

Market value of preferred shares= 500,000 * 10= $500,0000.

Market value of debt =$50 million * 1150= $57500 million

WACC Formula = (E/A * Ke) + (D/A) * Kd * (1 – Tax rate)

E = Market Value of Equity
A = Total market value of equity & debt
Ke = Cost of Equity
D = Market Value of Debt
Kd = Cost of Debt
Tax Rate = Corporate Tax Rate

Cost of equity can be found by DDM

Ke= Expected Dividend in 1 year ÷ Current Stock Price + Growth Rate

Ke=7/(56+0.02)=0.124

WACC=((84/(84+57500)*0.124)+(57500/(84+57500))*0.07*(1-0.35)= 0.045 or 4.5%

So the firms cost is 4.5%

jeff jeffy answered 1 year ago

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