Cost of Capital Now: Suppose the cost of debt is 8.50% (before tax) The tax rate
ID: 2739365 • Letter: C
Question
Cost of Capital Now: Suppose the cost of debt is 8.50% (before tax) The tax rate is .45 D_0 = $2.95 g = 3.05% Beta = 1.70 r_w = 2.25% RP_m = 5.50% (Market Risk Premium) Flotation costs (F) = 5% of issue price The debt is trading at $998.25. with 7,676 bonds outstanding. The firm has 225,000 shares of common stock outstanding, which are trading at $37.95/share (P_0). Given the above information, what is the Market value of the firm's debt? $ Given the above information, what is the Market value of the firm's equity? $ Now calculate the weight of debt for the firm (W_d). You will use this to calculate the WACC. Now calculate the weight of equity for the firm (W_ce). You will use this to calculate the WACC. What is (calculate) the cost of existing common equity (retained earnings)? (Briefly describe your approach/method as well as your answer) What is (calculate) the firm's Weight Average Cost of Capital (WACC)? (Briefly describe your approach/method as well as your answer)Explanation / Answer
Market value of debt = Bonds outstanding * market price of bonds
= 7676 * $ 998.25
=$ 7662567
Market value of firm’s equity = share outstanding * Trading price of shares
= 225000 * $37.95
= 8538750
Weight of debt = 7662567 / (7662567 + 8538750)
= 0.47
Weight of equity = 8538750 / (7662567 + 8538750)
= 0.53
B) Cost of existing common equity = D0*(1+ g) / P0
= 2.95* (1+ 0.0305) / 37.95
=8%
(CAPM MODEL) = rRF + beta*RPm
= 2.25 + 1.7 * 5.5
= 11.6 %
Cost of debt (after tax)= cost of debt before tax * (1 – tax)
= 8.5 * (1- 0.45)
= 4.675
Firm’s weight Average cost of capital (WACC) = cost of equity * weight of equity + Cost of debt * weight of debt
= 8 * .47 + 4.675* .53
=6.24 %
(CAPM) = Firm’s weight Average cost of capital (WACC) = cost of equity * weight of equity + Cost of debt * weight of debt
= 11.6 * .47 + 4.675* .53
=7.93 %