Thorpe and Company is currently an? all-equity firm. It has three million shares
ID: 2615185 • Letter: T
Question
Thorpe and Company is currently an? all-equity firm. It has three million shares selling for ?$39 per share. Its beta is 1.3 and the current? risk-free rate is 3.4%. The expected return on the market for the coming year is 9.3?%. Thorpe will sell corporate bonds for 39,000,000 and retire common stock with the proceeds. The bonds are? twenty-year semiannual bonds with a 9.4?% coupon rate and $1,000 par value. The bonds are currently selling for ?$1,127.70 per bond. When the bonds are? sold, the beta of the company will increase to 1.6. What was the WACC of Thorpe and Company before the bond? sale? What is the adjusted WACC of Thorpe and Company after the bond sale if the corporate tax rate is 25%??
Hint?: The weight of equity before selling the bond is? 100%.
Explanation / Answer
Risk free rate Rf = 3.4%
Expected return from martet Rm = 9.3%
Beta or the company is ? = 1.3 before issue of Bonds
Cost of equity under CAPM method = Rf + ? (Rm - Rf)
= 3.4% + 1.3 (9.3% + 3.4%)
= 11.07%
WACC berfore issue is the cost of equity because only one source is existed
So WACC before isuue of Bond is = 11.07%
Total equity out standing berfore issue of Bonds is 3 millinons
Equity value is 3millions X $39 = $ 117 millions
Proceeds from Bonds issue = $ 39 millions
Par value of the bond = $ 1000
No of Bonds issued = 39000000/1000
= 39000
Coupon rate of bond is = 9.4%
Coupon rate after tax is Rc = 9.4%(1-.25) = 7.05%
Out standing equity is = $ 117 millions - $39 millions
= $ 78 millions
Total capital = $ 78 millions of equity + $ 39 millions of Bonds
= $ 117 millions
Beta vaule after Bonds issue is = 1.6
Cost of equity after Bonds issue Re = Rf + ? (Rm - Rf)
= 3.4% + 1.6 ( 9.3% - 3.4%)
Re= 12.84%
Weihgtage of equity is We = 78/117 = .67
Weightage of Bonds Wb = 39/117 = .33
WACC after bonds issue = (We X Re) + ( Wc X We)
WACC after bonds issue = (.67 x 12.84%) + (.33 x 7.05%)
= 10.93%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.