8.8 You have the following information about Burgundy Basins, a sink manufacture
ID: 2751409 • Letter: 8
Question
8.8 You have the following information about Burgundy Basins, a sink manufacturer.
Equity shares outstanding- 20 million
Stock price per share- $40.00
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- $290 million
Book value of equity- $500 million
Cost of equity capital- 14%
Tax rate- 35%
Burgundy is contemplating what for the company is an average-risk investment costing $40 million and promising an annual ATCF of $6.4 million in perpetuity.
a. What is the internal rate of return on the investment?
b. What is Burgundy’s weighted-average cost of capital?
c. If undertaken, would you expect this investment to benefit share-holders? Why or why not?
Explanation / Answer
b. Burgundy’s weighted-average cost of capital:- (Using Market value weights)
(NOTE 1):- Cost of equity = 14 % (Given)
(NOTE 2):- Cost of Debt = 4.8 ( 1 - 0.35) = 3.12 %.
(Using Book value weights)
(NOTE 1):- Cost of equity = 14 % (Given)
(NOTE 2):- Cost of Debt = 4.8 ( 1 - 0.35) = 3.12 %.
Conclusion:- Burgundy’s weighted-average cost of capital:
Weight Cost Weight * Cost Equity= $ 800 Milion 0.73 14 10.22 Debt = $ 290 Milion 0.27 3.12(NOTE 2) 0.8424 Total = $ 1090 1 11.0624 i.e., 11.06 % (Rounded off)
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