The company has currently 20 000 shares outstanding. The book value per share is
ID: 2796932 • Letter: T
Question
The company has currently 20 000 shares outstanding. The book value per share is $20. The stock is currently trading at the P/B ratio of 2.0; P/E= 14 and EV/EBITDA=7.5. It is also known that the risk free rate is 2%, the beta of the stock is 2.0 and the market risk premium over risk free rate is equal to 5%. You may assume that the marginal tax rate on profits is 25%.
The company is going to issue 6 000 coupon bonds with the par value of $100 per bond, 6% annual coupon rate. Similar bonds currently trade at 4% yield level . The bonds will mature exactly 8 years from now.
Find:
a) Cost of debt and equity
b) The shares of debt and equity in capital structure
c) Find WACC and interpret your result?
Explanation / Answer
a) Cost of Debt = Coupon rate * ( 1- Tax Rate) = 0.06 * 0.75 = 4.5 %
Cost of Equity = Risk free rate + beta * market risk premium = 0.02 + 2 * 0.05 = 12%
b) The Market value of shares is 20000 * Market Price of the share
Now we have P/B = 2 which means Price of the share is 20* 2 = 40
Thus MV = 800,000
Now the YTM = 4%, thus the MV of Debt = 113.47 dollars per share or 680793 dollars in total (Approx)
Thus we have Weight for Equity = 800000 / ( 800000 + 680793) = 54%
Weight for Debt = 680793 / ( 800000 + 680793) = 46% (Approx)
c) Now WACC = 0.54 * 0.12 + 0.46 * 0.045 = 8.55%
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