Problem 11-15 WACC Estimation On January 1, the total market value of the Tyssel
ID: 2783605 • Letter: P
Question
Problem 11-15 WACC Estimation On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $25 million in new projects. The firm's present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt. Debt Common equity Total capital $30,000,000 30,000,000 $60,000,000 New bonds will have an 9% coupon rate, and they will be sold at par. common stock is currently selling at $30 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 next expected dividend is $1.20, so $1.20/$30-496.) The marginal corporate tax rate is 35%. a. In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Enter your answer in dollars. For example, $1.2 million should be entered as $1200000 b. Assuming there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity, what is its WACC? Round your answer to two decimal places. c. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? -Select- I. rs will increase and the WACC will decrease due to the flotation costs of new equity. II. rs will decrease and the WACC will increase due to the flotation costs of new equity. III. rs and the WACC will not be affected by flotation costs of new equity. IV. rs and the WACC will increase due to the flotation costs of new equity. V. rs and the WACC will decrease due to the flotation costs of new equity.Explanation / Answer
1
The current D/E=1/1
So, Debt and Equity must be equal
If 25 million needs to be raised, extra Debt and Equity must be equal each to 12.5 million
2
Without addiitnal equity
Current proportion of debt=30/60=0.5
Current proportion of equity=30/60=0.5
Cost of debt=9% (as they are sold at par, ytm=coupon rate)
cost of equity=12%
So, WACC=cost of debt*(1- tax rate)*proportion of debt + cost of equity*proportion of equity
WACC=9*(1-35%)*0.5+0.5*12=8.925%
3
Option IV
Now if additional equity must be raised, proportion of debt and equity would reamin the same at 0.5
only cost of floatation is the additional factor
hence, cost of equity would rise and thus WACC would rise