Cost of debt is 7% (before tax). ⢠The tax rate is 45%. ⢠D0 = $2.75 ⢠g = 3%
ID: 2660763 • Letter: C
Question
Cost of debt is 7% (before tax).
⢠The tax rate is 45%.
⢠D0 = $2.75
⢠g = 3%
⢠Beta = 1.2
⢠rRF = 4.1%
⢠RPm = 6%
⢠Flotation costs (F) = 5% of issue price.
⢠The debt is trading at $1,048.75 with 7,133 bonds outstanding.
⢠The firm has 200,000 shares of common stock outstanding, which are trading at $35.36/share (P0).
(Show each step for each answer)
1.Given the above information, what is the market value of the firm's debt?
2.Given the above information, what is the market value of the firm's equity?
3.Now calculate the weight of debt for the firm (Wd).
4.Now calculate the weight of equity for the firm (Wce).
5.What is the cost of existing common equity (retained earnings)?
6.What is the firm's cost of capital (WACC)?
Explanation / Answer
market value of the firm's debt = $1048.75*7133 = $7480733.75
market value of the firm's equity = 200,000*$35.36 = $7072000
weight of debt for the firm (Wd) = $7480733.75/( $7480733.75+$7072000) = 0.5140
weight of equity for the firm (Wce) = 1-Wd = 0.4860
cost of existing common equity (retained earnings) = 4.1+1.2(6-4.1) = 6.38%
firm's cost of capital (WACC) = 0.514(1-.45)*7 + 0.486*6.38 = 5.08%