The Imaginary Products Co. currently has debt with a market value of $275 millio

Question

The Imaginary Products Co. currently has debt with a market value of $275 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $1,317.70 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $27. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 7 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm

Explanation / Answer

Similar problem just change values....

Market value of Debt = $50 million

Market value of equity = $22.50 * 10 million shares =$225 million

Total market value = $225 + $50 = $275 million

Weight of Market value of debt = $50/$275 *100 = 18.18%

Weight of Market value of Equity= $225/$275 *100 = 81.82%

Book value of Debt = $45 million

Book value of Equity = $65 million

Total Book value = $45 + $65 = $110 million

Weight of Book value of debt = $45/$110 *100 = 40.91%

Weight of Book value of Equity= $65/$110 *100 = 59.09%

WACC= WdRd(1-t) + We*Re

Bond yield (rd) = 6%

tax rate = 40 %

Cost of equity (re) = 14%

WACC at Market value = .1818*6(1-.40)+.8182*14 = 12.11%

WACC at Book value = .4091*6(1-.40)+.5909*14 = 9.75%

Difference between these two WACCs = 12.11% - 9.75% = 2.36%

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