a. Cost of debt (weighted average of bond YTMS) b. Cost of equity (use CAPM) c.

Question

a. Cost of debt (weighted average of bond YTMS) b. Cost of equity (use CAPM) c. The current stock price (use DGM) d. Total market value of equity e. Total market value of debt f. WACC The firm has 25 million shares of common stock outstanding. The beta is 1.4. The firm most recently paid a $3 dividend and plans to increase dividends by 25% each year for the next 2 years and then by 3% per year after that indefinitely. The expected return on the market portfolio is 13% and the risk-free rate is 3.5%. The firm has two bond issues outstanding. All bonds make annual coupon payments. o Bond 1 is a 5% coupon bond with face value of $1000. The YTM is 4% and the bonds mature in 14 years. There are 10,000 of these bonds. o Bond 2 is a zero coupon bond with face value of $5000. The YTM is 3% and the bonds mature in 22 years. There are 74,000 of these bonds. The firm's average tax rate is 30%.

Explanation / Answer

Part - A

Cost of Debt

Value per Bond 1 & 2

Bond 1

Bond 2

Cost of Debt = Interest after Tax +Amortisation/Average price

=50(1-0.30)+(1106-1000/14)

_______________________

1106+1000/2

=35+7.57/1053

=4.04%

Part - B

Cost of Equity = Risk Free Rate +Beta (Rm-Risk Free Rate)

=3.50+1.40(13-3.50)

=16.80%

Part - C

Current Stock Price

Nptes

FCFF 3 = D2(1+g)ke-g

=4.6875(1.03)/0.168-0.03

=4.821/0.138

=34.99

Value Per Share = 32.30

Part - D

Market Value of Equity

= 25 Million Stock * $ 32.30

=807.50 Million

Part - E

Market Value of Debt

Bond 1 = 1106*10000

=11.06 Million

Bond 2 =2609.50*74000

=193.1

Total Value of Debt = 11.06 Million + 193.10 Million

=204.16

Part - F

Calculation of WACC

WACC =13.88%

Particulars Year Cashflow PVF @ 4% DCF Interest 1-14 50 10.5631 528.16 Maturity 14 1000 0.5775 577.50 Total 1106

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