On January 1, the total market balue of the Tysseland Company was 60 million. Du
ID: 2680395 • Letter: O
Question
On January 1, the total market balue of the Tysseland Company was 60 million. During the year, the company plans to raise and invest 30million in new projects. The fir's present market value capital structure ( debt = 30 million common equity = 30 million) New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 share. The stockholders' required te of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8% (the next expected dividend is $1.20, so the dividend yield is $1.20/4$30 = 4%) The marginal tax rate is 40%.a.) In order to maintain the present capital structure, how mucof the new investment must be financed by common equity?
b.) Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional share of equity, what is its WACC?
c.) Suppose now that there it not enough internal cash flow and the firm must issue new shares of stoc. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question.
Explanation / Answer
a. to maintain the present capital structure, how much of the new investment must be financed by common equity? the answer is $15,000,000 how do I arrive at this number? .Required Investments = $30,000,000 Since the total market value of the firm is $60,000,000 Out of that, $30,000,000 is financed through equity, then the weight of equity = $30,000,000 / $60,000,000 = 0.5 Common equity needed = Total Amount of Investment × Weight of Equity = 0.5($30,000,000) = $15,000,000. b. Assume there is sufficient cashflow so the co. can maintain its target capital structure w/o issuing additional shares of equity. what is the WACC? answer is 8.4%, how do I arrive at this number? Cost of Equity = = = 0.12 = 12% After Tax Cost of Debt = Before Tax Cost of Debt × (1-Tax Rate) = 8 × (1-0.4) = 4.8% WACC = (Weight of Equity × Cost of Equity) + (Weight of Debt × After Tax Cost of Debt) = (0.5 × 12%) + (0.5 × 4.8%) = 8.4%