Question

Use the following information to answer questions

19 through 24.A corporation has 10,000 bonds outstanding with a 6% annual coupon rate, 8 years to maturity, a $1,000 face value, and a $900 market price.

The company’s 500,000 shares of common stock sell for $10per share, have a beta of 1.5, the risk-free rate is 4%, and the market risk premium is 8%.

19.What is the market value of equity for this corporation?

A.$5 million

B.$11 million

C.$12.5 million

D.$4 billion

E.none of the above

20.

What is the market value of debt for this corporation?

A.$10 million

B.$11 million

C.$1 billion

D.$1.1 billion

E.none of the above

21. What is the cost of equity for this corporation?

A.6%

B.12%

C.16%

D.22%

E.none of the above

22. What is the pre-tax cost of debt for thiscorporation?

A.2.69%

B.4.48%

C.6.00%

D.7.72%

E.none of the above

23. Assuming a 25% tax rate, what is this corporation’s after-tax cost of debt?

A.2.69%

B.4.48%

C.5.79%

D.8.97%

E.none of the above

24. What is the weighted average cost of capital for this company?

A.9.44%

B.9.77%

C.10.24%

D.13.24%

E.none of the above

Answer 1

Answer 19: Option A. 5 million $ - The total value of equity = Number of shares * Price of share = 500,000*$10 = $ 5 million

Answer 20: Option E: none of the above - The market value of debt = Number of bonds * Market price of bonds = 10,000*900$ = $ 9 million

Answer 21: Option C: 16% - The formula for Cost of Equity = Rf + beta*Rm

where Rf is the risk free rate, beta is the stock beta and Rm is market risk premium. So cost of equity = 4% +1.5*8% = 4% + 12% = 16%

Answer 22: Option D: 7.72%. For this we lay out the cash flows of the bond and calculate the IRR

Year	0	1	2	3	4	5	6	7	8
Cashflow	-900	60	60	60	60	60	60	60	1060
IRR	7.72%	IRR(C6:K6)

Answer 23:Option C: 5.79% - Post tax cost of debt = pre tax cost of debt * (1-Tax rate) = 7.72*(1-25%) = 5.79%

Answer 24: Option A: 9.44%- WACC = D/(D+E)*rd*(1-T) + E/(D+E)*re

where D is the market value of debt = 9 millionn $

E is the market value of Equity = 5 millionn $

rd = pre-tax cost of debt

T = tax rate

re = cost of equity

WACC = 9/(5+9)*7.72*(1-25%)% +5/(5+9)*16% = 9.44%

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