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Question 6 Consider the following balance sheet of a publicly held company: Cash $760,000 Long Term...

Question 6

Consider the following balance sheet of a publicly held company:

Cash $760,000 Long Term Debt $7,633,500
Receivables $1,250,000 Common Stocks $14,176,500
Inventories $2,225,000
Net Equipment $17,575,000

It is estimated that the yield to maturity on bonds are 9%. The company faces a marginal tax rate of 28%. Assume that stock price of this company rises such that it would sell at 1.35 times its book value (amount in the balance sheet) causing its cost of equity to move to 11.5%.

What would be the weighted average cost of capital for this firm?

		10.07%
		9.31%
		9.91%
		8.41%

Question 7

Consider the following balance sheet of a publicly held company:

Cash $760,000 Long Term Debt $7,633,500
Receivables $1,250,000 Common Stocks $14,176,500
Inventories $2,225,000
Net Equipment $17,575,000

Currently the stocks are selling for a price equal to its book value and bonds are selling at par. It is estimated that the stockholders require a return of 13% while the yield to maturity on bonds are 9%. The company faces a marginal tax rate of 34%. What is the weighted average cost of capital for this firm?

		7.95%
		10.53%
		8.41%
		9.31%

Expert Solution

1)MV of equity = 1.35*14176500=19138275

Total Capital value = Value of Stock + Value of Debt

=19138275+7633500

=26771775

Weight of Stock = Value of Stock/Total Capital Value

= 19138275/26771775

=0.7149

Weight of Debt = Value of Debt/Total Capital Value

= 7633500/26771775

=0.2851

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 9*(1-0.28)

= 6.48

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=6.48*0.2851+11.5*0.7149

WACC =10.07%

2)

Total Capital value = Value of Stock + Value of Debt

=14176500+7633500

=21810000

Weight of Stock = Value of Stock/Total Capital Value

= 14176500/21810000

=0.65

Weight of Debt = Value of Debt/Total Capital Value

= 7633500/21810000

=0.35

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 9*(1-0.34)

= 5.94

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=5.94*0.35+13*0.65

WACC =10.53%

jeff jeffy answered 1 year ago

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