Bonaime, Inc., has 3.9 million shares of common stock outstanding. The current s
ID: 2811349 • Letter: B
Question
Bonaime, Inc., has 3.9 million shares of common stock outstanding. The current share price is $84, and the book value per share is $11. Stock in Bonaime, Inc. has a beta of 1.10. The market risk premium is 7.8 percent, and T-bills are currently yielding 0.76 percent. Bonaime's most recent dividend was $2.67 per share, and dividends are expected to grow at an annual rate of 6 percent indefinitely.
The company also has a bond issue outstanding with semi-annual coupon payments. The bond issue has a face value of $105 million, a coupon rate of 6.3 percent, sells for 98 percent of par, and matures in 20 years. The tax rate for the company is 30%.
Please answer all the following questions:
a. What is the firm's before-tax cost of debt?
b. What is the firm's cost of equity using the CAPM model?
c. What is the firm's cost of equity using discounted cash flow approach?
d. What is the weight of debt and equity using book value? What is the WACC?
e. What is the weight of debt and equity using market value? What is the WACC?
f. Which are more relevant, the book value or market value weights? Why?
Pad 9:39 PM instructure-uploads.s3.amazonaws.com iven Equity information Curent share price Shares outstandin Book Value per share Bond information Face value Coupon rate Market price Number of coupon payment per year Years to matur Other information Beta Market risk premiunm T-bill yield Last dividend Dividend growth rate Tax rate Part a Cost of Debt Working Area Cost of Equity CAPM Approach Part b: Cost of Equ DCF Approach Part c: Book Value Based Total firm value Weight of Debt Weight of Equity WACC Part d: Part e Book Value Based Total firm value Weight of Debt Weight of Equit WACC Part fExplanation / Answer
1. Cost of debt is generally the YTM of the bond.
Par Value=100, Market value=98 Coupon rate=6.3%, Years=20..we need to calculate YTM...
I/Y= 5.24%..This is cost of debt of bond.
2. Cost of equity= rate of t bills( Rf)+beta* market risk premium
= 0.76+1.1*7.8
=9.34
3.Cost of equity using discounted cash flow (r) is
r= Dividend*(1+growth)/Market price+growth
=2.67*(1.06)/84+0.06
=9.36%
4.Total debt=105 million if used book value
Total equity=3.9*11 million=42.9 million
WACC= weight of equity*re(usecapm) + weight of debt*de*(1-t)
= 42.9/147.9*9.34+105/147.9*5.24*0.7
=2.709+2.60
=5.3
5. Similarly Market Value of equity=3.9million
=327.6 million...MV of debt= 0.98*105 million=102.9 million
Hence we=327.6/(102.9+327.6)=76.1%..WD=23.9%
WACC=0.76*9.34+0.24*5.24*0.7
=7.1+0.88
=7.98%
6. Between book value and market value market value is more relevant as it gives current true value of the company. Book value just gives the balance sheet value if the company and not its true intrinsic value.