Caribou Café corp. is evaluating its capital structure. The balance sheet of the
ID: 2544497 • Letter: C
Question
Caribou Café corp. is evaluating its capital structure. The balance sheet of the company is as follows (in million AED) ( show the answer is detailed steps):
Assets
Liabilities
Fixed Assets
4000
Debt
3000
Current Assets
2000
Equity
3000
In addition, you are provided the following information:
-The debt is in the form of long term bonds which are currently rated AA and are selling at a yield of 15% (the market value of the bonds is 2/3 of the face value).
-The firm currently has 60 million shares outstanding, and the current market price is AED 90 per share.
-If the firm has to pay 15% interest to the bank and assumes 17% returns to the equity holders
-What is the value of the firm in book values 60,000,000 shares and the market price/share is AED90?
-What is the value of the firm in market values?
-What is the weighted average cost of capital?
Assets
Liabilities
Fixed Assets
4000
Debt
3000
Current Assets
2000
Equity
3000
Explanation / Answer
Book value of the firm=Total assets-Liabilities=Fixed assets+Current assets-Debt=4000+2000-3000=3000 million AED
Market value of the firm=Market value per share*Number of shares outstanding =AED 90*60 million shares=5400 million AED
Weighted average cost of capital(WACC)=(E/V*Re)+[D/V*Rd*(1-Tc)]
where
E=Market value of the firm's equity, D=Market value of the firm's debt, V=E+D,E/V=Percentage of equity financing, D/V=Percentage of debt financing, Re=Cost of equity, Rd=Cost of debt, Tc=Corporate tax rate
WACC=[3000/(3000+2000)]*17%+[2000/(3000+2000)*15%=0.162=16.2%
Market value of debt=2/3*3000=2000 million AED, Corporate tax rate is assumed to be nil in the absence of information