Assume that you have been hired as a consultant by CGT, a major producer of chem
ID: 2653995 • Letter: A
Question
Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below.
Assets
$38,000,000
$101,000,000
$139,000,000
Liabilities and Equity
$10,000,000
$9,000,000
$19,000,000
$40,000,000
$59,000,000
$30,000,000
$50,000,000
$80,000,000
$139,000,000
The stock is currently selling for $15.00 per share, and its noncallable $1,000 par value, 20-year, 7.25% bonds with semiannual payments are selling for $1,150.00. The beta is 1.35, the yield on a 6-month Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5 years. The firm's tax rate is 40%.
Which of the following is the best estimate for the weight of debt for use in calculating the WACC?
$38,000,000
Net plant, property, and equipment$101,000,000
Total assets$139,000,000
Explanation / Answer
Current selling price of common share = $15.00 per share
Number of outstanding share = 10 Million
Number of Bond (Outstanding) = 40,000
Price of Bond (Outstanding) = $1,150.00
Total Value of Equity = Market price per share*Oustanding Shares
Total Value of Equity = $15.00*10,000,000 shares
Total Value of Equity = $150,000,000
Total value of debt = Number of Outstanding bond*Price per bond
Total value of debt = 40,000*$1,150
Total value of debt = $46,000,000
So,
Total Value of firm = Total value of debt + Total Value of Equity
Total Value of firm = $46,000,000 + $150,000,000
Total Value of firm = $196,000,000
Weight of debt = Total value of debt / Total Value of firm
Weight of debt = $46,000,000 / $196,000,000
Weight of debt = 0.2346 or 23.46%
WACC = 23.46%