Use the following information for questions 18-24. A corporation has 6,000,000 s
ID: 2621909 • Letter: U
Question
Use the following information for questions 18-24. A corporation has 6,000,000 shares of stock outstanding at a price of $40 per share. They just paid a dividend of $2 and the dividend is expected to grow by 8% per year forever. The stock has a beta of 1.4, the current risk free rate is 4%, and the market risk premium is 7%. The corporation also has 800,000 bonds outstanding with a price of $1,100 per bond. The bond has a coupon rate of 11% with semiannual interest payments, a face value of $1,000, and 13 years to go until maturity. However, the bond can be called in 4 years for $1,050. The company plans on paying off their debt until they reach their target debt ratio of 60%. They expect their cost of debt to be 8% and their cost of equity to be 11% under this new capital structure. The tax rate is 40%
18. What is the required return on the corporation
Explanation / Answer
18) r =RFR + Beta * (Market return -RFR ) = 0.04 + 1.4*0.07 = 0.138 = 13.8%
19)r = [ D*(1+g)/P ] + g = [ 2*1.08/40 ] + 0.08 = 0.134 = 13.4%
20)1100 = ( 110/ YTM/2 )*(1-(1+YTM/2)^-26) + 1000/(1+YTM/2)^26
YTM = 4.82*2 = 9.64%
21)D/(D+E) = 800000*1100/(800000*1100 + 6000000*40) = 0.78 = 78%
22)WACC = ( D/(D+E) ) * (1-T)*cost of debt + ( E/(D+E) ) * cost of equity = 0.6*(1-0.4)*0.08 + 0.4*0.11 = 0.0728 = 7.28%
23)r = 0.08/2 = 0.04 , n = (13-4)*2 = 18
P = (110/0.04)*(1-(1+0.08/2)^-18) + 1000/(1+0.08/2)^18 = $1886.15
24)P = D*(1+g)/(r-g) = 2*1.08/(0.11-0.08) = $72