The expected return on the market is 12%. The risk-free rate is 3.5% Bacon Every
ID: 2751916 • Letter: T
Question
The expected return on the market is 12%.
The risk-free rate is 3.5%
Bacon Everything, INC! has a current stock price of $65. There are 15 million shares outstanding. The beta for the stock is 1.6.
Bacon Everything INC! has a plowback ratio of 40%.
Bacon Everything INC! has three different bond issues as follows:
- 8% coupon bonds with face value of $1000 that matures in 10 years. These bonds have a yield to maturity of 6% There are 250,000 of these.
-Zero- coupon bonds with face value of $1000 that mature in 3 years. These bonds have a yield to maturity of 3%. There are 300,000 of these bonds.
-10% coupon bonds with face value of $1000 that mature in 15 years and are currently trading at face value. There are 500,000 of these bonds.
Bacon Everything INC has an average tax rate of 30%
Bacon Everything INC! has no preferred stock.
1. What is the cost of equity for Bacon Everything INC?
2. What is bond value for the 8% coupon bonds outstanding? What are current yield and capital gains yield?
3. What is bond value for the zero-coupon bonds? What are current yield and capital gains yield?
4. What is the cost of debt for Bacon Everything, INC!?
5. Calculate WACC using market values to obtrain weights.
Please show all work and steps.
Thank you.
Explanation / Answer
Marker Reurn Rm= 12.00% Risk Free Rate =Rf 3.50% Beta of stock 1.60 Cost of equity =Rf+Beta*Rm =0.035+1.60*0.12 = 22.70% 1 Cost of equity = 22.70% current stock price 65 Outstanding shares 15,000,000 Market value equity= 975,000,000 8% coupon Bonds Valuation Year Interest +Maturity discount factor@6% PV of cash flows Year 1 80.00 0.9434 75 Year 2 80.00 0.8900 71 Year 3 80.00 0.8396 67 Year 4 80.00 0.7921 63 Year 5 80.00 0.7473 60 Year 6 80.00 0.7050 56 Year 7 80.00 0.6651 53 Year 8 80.00 0.6274 50 Year 9 80.00 0.5919 47 Year 10 1,080.00 0.5584 603 Total 1,147 So current Bond Price 8% Bond 1,147 No of Bonds 250,000 2 Market Value of 8% Bonds 286,750,000 Current yield=coupon/Price= 6.97% Capital Gains=-147/1147 -12.82% (At maturity) Zero Coupon Bonds Year Interest +Maturity discount factor@3% PV of cash flows Year 1 - 0.9709 - Year 2 - 0.9426 - Year 3 1,000 0.9151 915 Current price of zero coupon bond= $ 915.14 No Of Bonds 300,000 3 Market Value of Bonds 274,542,498 There is no current yield Capital Yiels=(1000-915.14)/915.14= 9.27% 10% Coupon Bonds Face value 1,000 Market value 1,000 Years to amturity 15 Coupon rate 10% YTM=[Coupon+(face value-market price)]/(Face value+2*market price)/3 =100/(1000)=10% So YTM = 10% No Of Bonds 500,000 Market Value 500,000,000 Bonds Market Value YTM Tax Post Tax YTM Weight Market Value Weighted cost 8% Bond 286,750,000 6% 30% 4.20% 27.02% 1.13% Zero Coupon Bond 274,542,498 3% 30% 2.10% 25.87% 0.54% 10% Bond 500,000,000 10% 30% 7.00% 47.11% 3.30% 1,061,292,498 4.98% 4 So post tax cost of debt = 4.98% WACC Market Value Weight Market Value cost Weighted cost Equity 975,000,000 47.88% 22.70% 10.87% Debt 1,061,292,498 52.12% 4.98% 2.59% Total 2,036,292,498 13.46% 5 So WACC = 13.46%
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