The Imaginary Products Co. currently has debt with a market value of $300 millio
ID: 2752390 • Letter: T
Question
The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $839.36 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $21. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 8 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?
a) Calculate the Weights for debt, common equity, and preferred equity.
b) Calculate the cost of preferred equity.
c) Calculate the cost of common equity.
d) What is the firm’s weighted average cost of capital?
The Imaginary Products Co. currently has debt with a market value of $300 million outstanding. The debt consists of 9 percent coupon bonds (semiannual coupon payments) which have a maturity of 15 years and are currently priced at $839.36 per bond. The firm also has an issue of 2 million preferred shares outstanding with a market price of $21. The preferred shares pay an annual dividend of $1.20. Imaginary also has 14 million shares of common stock outstanding with a price of $20.00 per share. The firm is expected to pay a $2.20 common dividend one year from today, and that dividend is expected to increase by 8 percent per year forever. If Imaginary is subject to a 40 percent marginal tax rate, then what is the firm’s weighted average cost of capital?
Explanation / Answer
Ans b
Workings
Ans a Details Debt Common Equity Preferred Equity Total Market Value 300.00 280.00 42.00 622.00 Weight 48.23% 45.02% 6.75% 100.00%Ans b
Ans b&c Details Formula Formula Cost of capital Cost of Prefered Equity D0/P 1.2/21 5.71% Cost of Common Equit D1/P0+g 2.2/20+8% 19.00% Ans d Details Formula Formula Cost of capital Weight WACC Cost of Prefered Equity D0/P 1.2/21 5.71% 0.07 0.39% Cost of Common Equit D1/P0+g 2.2/20+8% 19.00% 0.45 8.55% Cost of Bond 11.24% 0.48 5.42% 14.36%Workings
Cost of Bond Market Price(Present Value of the Bond) C*((1-1+r^-n)/r)+(P*(1+r^-n)) Where C=Semi annual Coupon amount=1000*6%*.5 45 r=Required rate(YTM) 11.24% P=Principal 1000 n=No of periods=15*2 30 Market Price(Present Value of the Bond) 839.36 Cost of Bond is the rate which equates cash flow to current Market price 11.24%Related Questions
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