You have the following information about Burgundy Basins, a sink manufacturer. E
ID: 2718080 • Letter: Y
Question
You have the following information about Burgundy Basins, a sink manufacturer.
Equity shares outstanding
20 million
Stock price per share
$50.00
Yield to maturity on debt
7.5%
Book value of interest-bearing debt
$320 million
Coupon interest rate on debt
4.8%
Market value of debt
$300 million
Book value of equity
$500 million
Cost equity of capital
12%
Tax rate
30%
Burgundy is contemplating what for the company is an average-risk investment costing $60 million and promising an annual ATCF of $5 million in perpetuity.
What is the internal rate of return on the investment? (hint: use the equation for a perpetuity)
What is Burgundy’s WACC?
If undertaken, would you expect this investment to benefit shareholders? Why and why not?
Equity shares outstanding
20 million
Stock price per share
$50.00
Yield to maturity on debt
7.5%
Book value of interest-bearing debt
$320 million
Coupon interest rate on debt
4.8%
Market value of debt
$300 million
Book value of equity
$500 million
Cost equity of capital
12%
Tax rate
30%
Explanation / Answer
0 = initial investment - annual ATCF/IRR
IRR = 5/60 = 8.333%
Market value of equity = share price*number of shares outstanding = 50*20 = 1000m
WACC = Market value of equity*cost of equity/(Market value of equity+Market value of debt) +
Market value of debt*cost of debt*(1 -tax rate)/(Market value of equity+Market value of debt)
= 1000*12/(1000+300)+300*7.5*(1-.3)/(1000+300) = 10.42231%
WACC is >IRR thus it will not benefit shareholders as NPV will be less than 0
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