A company has 5,000,000 shares of stock outstanding at a price of $35 per share.

Question

A company has 5,000,000 shares of stock outstanding at a price of $35 per share. They paid a dividend of $2 and the dividend is expected to grow by 8% per year forever. The stock has a beta of .8, the current risk free rate is 6%, and the market risk premium is 9%. The corporation also has 400,000 bonds outstanding with a price of $925 per bond. The bond has a coupon rate of 6% with semiannual interest payments, a face value of $1,000, and 14 years to go until maturity. The company plans on paying off their debt until they reach their target debt ratio of 60%. They expect their cost of debt to be 6% and their cost of equity to be 10% under this new capital structure. The tax rate is 40%.

1. Using their target capital structure and expected costs of debt and equity, what is their WACC?

2. What should the new price of the bond be given the new cost of debt?

3. What should the new price of the stock be given the new cost of equity?

*** Please show steps ***

Explanation / Answer

as it is given semi annually so coupon rate will be 6/2=3%

400000*3=12000

year 28=12000+1000=13000

now using financial calculator find out present value of cash flow i.e., sum of above=337000 @ 3%(as cost of debt is 6% so semi annually =6/2=3%)

so present value of cash flow= 225606.3755

year 1 12000.0000 year 2 12000.0000 year 3 12000.0000 year 4 12000.0000 year 5 12000.0000 year 6 12000.0000 year 7 12000.0000 year 8 12000.0000 year 9 12000.0000 year 10 12000.0000 year 11 12000.0000 year 12 12000.0000 year 13 12000.0000 year 14 12000.0000 year 15 12000.0000 year 16 12000.0000 year 17 12000.0000 year 18 12000.0000 year 19 12000.0000 year 20 12000.0000 year 21 12000.0000 year 22 12000.0000 year 23 12000.0000 continue below. 12000.0000 year 25 12000.0000 year 26 12000.0000 year 27 12000.0000 year 28 13000.0000

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