Johnson Inc has 2,000 bonds and 300,000 shares of common stock outstanding. The

Question

Johnson Inc has 2,000 bonds and 300,000 shares of common stock outstanding. The common stock has a beta of 1.3 and trades at $18 per share . The bonds are $1,000 face value with a 5% coupon rate, paid semiannually, and currently trade at $985. 8 years to maturity. The firm is in 40% tax bracket. You have estimated the market risk premium to be 6% and yield on 10 year U.S. treasuries is 4%. The CAPM holds.

A.What is the yield to maturity on the firm’s bonds?

B.) Using CAPM what is the required rate of return on firm’s equity?

C) What is the firms WACC?

Explanation / Answer

Solution.

A.What is the yield to maturity on the firm’s bonds :-

B.) Using CAPM what is the required rate of return on firm’s equity....

Formula = Rf + Beta (ER(m) - Rf)

Risk free rate = 6%

Beta = 1.3

ER(m) = 18%

= 6 + 1.3 (18 - 6 ) = 19.3%

C) What is the firms WACC ..

Calculation of WACC.

WACC = 16.54%

               

Computing the Yield-to-Maturity of a Bond F 1000 r 5% m 2 N 8 T 16 Fr/m 25 P 985 Yield per interest period 0.031836198 Interest Period Coupon Discount Factor Present Value 1 25 0.969146073 24.2287 2 25 0.939244112 23.4811 3 25 0.910264743 22.7566 4 25 0.882179501 22.0545 5 25 0.8549608 21.374 6 25 0.828581902 20.7145 7 25 0.803016897 20.0754 8 25 0.778240673 19.456 9 25 0.754228892 18.8557 10 25 0.730957969 18.2739 11 25 0.708405046 17.7101 12 25 0.686547968 17.1637 13 25 0.665365268 16.6341 14 25 0.644836137 16.1209 15 25 0.62494041 15.6235 16 25 0.605658544 15.1415

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