Part 1 Murphy Ink has bonds outstanding with a face value of $145,000.00 that ar
ID: 2803394 • Letter: P
Question
Part 1 Murphy Ink has bonds outstanding with a face value of $145,000.00 that are selling at par. It also has 12,000 shares of stock outstanding that are selling for $22.25 a share. The all-equity value of the firm is $425,000.00. The tax rate is 35.00%. By what amount has the value of the firm been decreased by the expected bankcruptcy costs? Assume there are no other claims on the firm. PART 2 The iggy corporation stock has a beta that is 15.00% higher than the overall market beta. The risk free rate is 2.25% and the market rate of return is 8.75%. What is the cost of equity?
Explanation / Answer
Par 1
All equity value of firm = $425,000
if company add debt then vaue of firm = $145,000 + (12,000 × $22.25)
= $145,000 + $267,000
= $412,000
Value of levered firm is $412,000.
Value of firm decrease = $425,000 - $412,000
= $13,000
value of the firm been decreased by the expected bankcruptcy costs is $13,000.
Part 2
Beta = 1.15
Risk free rate = 2.25%
Market return = 8.75%.
Cost of equity is calculated below using CAPM model:
Cost of equity = Risk free rate + (Market Return – Risk free rate) × Beta
= 2.25% + (8.75% – 2.25%) × 1.15
= 2.25% + (6.50% × 1.15)
= 2.25% + 7.475%
= 9.725%
Cost of equity for company is 9.725%.