Information Use the following information about Rex Inc. for problems 1-6. Commo
ID: 1174863 • Letter: I
Question
Information
Use the following information about Rex Inc. for problems 1-6.
Common stock: 100,000 shares outstanding. $50 per share, beta=1.5
Bonds: 2,000 bonds outstanding, $1,000 face value each, 4% coupon paid semiannually, 21 years to maturity, market price of $995 per bond.
Market risk premium=5%, yield on 30 day Treasury Bill= 1%, effective tax rate = 21%
A) What is Rex Inc's Weight of Debt?
B) What is Rex Inc's Weight of Equity?
C) What is Rex Inc's Before Tax Cost of Debt?
D) What is Rex Inc's After Tax Cost of Debt?
E) What is Rex Inc's Cost of Equity?
F) What is Rex Inc's WACC?
Explanation / Answer
Market value of debt = 2,000 * 995 = 1,990,000
Market value of common stock = 100,000 * 50 = 5,000,000
Total market value = 1,990,000 + 5,000,000 = 6,990,000
a)
Weight of debt = 1,990,000 / 6,990,000
Rex Inc's Weight of debt = 0.2847
b)
Weight of equity = 5,000,000 / 6,990,000
Rex Inc's Weight of equity = 0.7153
c)
Coupon payment = 0.04 * 1000 = 40 / 2 = 20 ( since it is a semi annual bond, se divide by 2)
Number of periods = 21 * 2 = 42
Rex Inc's Before Tax Cost of Debt using a financial calculator = 4.036%
Keys to use in a financial calculator: 2nd I/Y 2, PV -995, FV 1000, N 42, PMT 20, CPT I/Y
d)
After tax cost of debt = 0.04036 ( 1 - 0.21)
Rex Inc's after tax cost of debt = 0.031884 or 3.1884%
e)
Cost of equity using CAPM = risk free rate + beta (market risk premium)
cost of equity = 0.01 + 1.5 ( 0.05)
Rex Inc's cost of equity = 0.085 or 8.5%
f)
WACC = weight of debt * cost of debt + weight of equity * cost of equity
WACC = 0.2847 * 0.031884 + 0.7153 * 0.085
WACC = 0.009077 + 0.060801
Rex Inc's WACC = 0.069878 or 6.9878%