On January 1, the total market value of the RXR Company was $100 million. During
ID: 2732523 • Letter: O
Question
On January 1, the total market value of the RXR Company was $100 million. During the year, the firm plans to raise and invest $30 million in a new project. Compared to the risks of the firm's existing assets, the project is about average-risk. The firm's present market value capital structure, shown below, is considered optimal. There is no short-term debt. Debt: $40,000,000 common equity: $60,000,000 Total capital: $100,000,000 New bonds will have a 8% coupon rate, and they will be sold at par. Common stock is currently selling at $40 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. The corporate tax rate is 40%. Assume that the firm intends to finance the new projects in a way that maintains the current capital structure. Further assume that the firm has sufficient cash such that it would not need to issue new common stock to finance the project, what is the WACC for the project?
Explanation / Answer
Answer:- (a)- Weight of equity = equity / total capital
Equity = $60,000,000
Total equity=$100,000,000
Weight of equity=60%
Investment to be financed by CE=18,000,000
(b)- WACC = (weight of equity * cost of equity)+(weight of debt *after tax cost of debt)
D1=1.6 P0=$40 G=8% Cost of equity=12% Weight of debt=40% After tax cost of debt=4.8
WACC =(60%*12%)+(40%*4.8%) =9.12%