Gentrix Inc. has two major sources of financing—common stock and long-term debt. They currently have 1,000,000 shares of stock outstanding, which are trading at a price of $20 per share. Two years ago, they issued $5,000,000 of 20-year debt to the general public at par value. The debt pays an annual coupon of 7%. The coupon is paid annually. Given their current capital structure, Gentrix has estimated that their cost of equity is 15%. Gentrix faces a marginal tax rate of 40%. It has been exactly two years since Gentrix issued their debt, and interest rates have increased. If the long-term debt is currently having a yield to maturity of 9%, what is the current value of the outstanding debt? Is it selling at a premium or discount to par value? (Remember that coupon payments of 7% are made annually rather than the semiannually.) Based on Gentrix’s current capital structure, what is the firm’s weighted average cost of capital? Assume that Gentrix currently has a capital structure that is 80% equity and 20% debt. The firm has decided to issue debt to retire equity such that their resulting capital structure is 60% equity and 40% debt. The firm has determined that they can comfortably afford the higher debt levels without any material effect on their competitiveness or financial condition. Once the capital structure is changed, what is the cost of equity and what is the weighted average cost of capital? Does the value of the firm increase or decrease? Please explain.
Gentrix Inc. has two major sources of financing—common stock and long-term debt. They currently have 1,000,000 shares of stock outstanding, which are trading at a price of $20 per share. Two years ago, they issued $5,000,000 of 20-year debt to the general public at par value. The debt pays an annual coupon of 7%. The coupon is paid annually. Given their current capital structure, Gentrix has estimated that their cost of equity is 15%. Gentrix faces a marginal tax rate of 40%. It has been exactly two years since Gentrix issued their debt, and interest rates have increased. If the long-term debt is currently having a yield to maturity of 9%, what is the current value of the outstanding debt? Is it selling at a premium or discount to par value? (Remember that coupon payments of 7% are made annually rather than the semiannually.) Based on Gentrix’s current capital structure, what is the firm’s weighted average cost of capital? Assume that Gentrix currently has a capital structure that is 80% equity and 20% debt. The firm has decided to issue debt to retire equity such that their resulting capital structure is 60% equity and 40% debt. The firm has determined that they can comfortably afford the higher debt levels without any material effect on their competitiveness or financial condition. Once the capital structure is changed, what is the cost of equity and what is the weighted average cost of capital? Does the value of the firm increase or decrease? Please explain.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Gentrix Inc. has two major sources of financing—common stock and long-term debt. They currently have 1,000,000 shares of stock outstanding, which are trading at a price of $20 per share. Two years ago, they issued $5,000,000 of 20-year debt to the general public at par value. The debt pays an annual coupon of 7%. The coupon is paid annually.
Given their current capital structure, Gentrix has estimated that their
- It has been exactly two years since Gentrix issued their debt, and interest rates have increased. If the long-term debt is currently having a yield to maturity of 9%, what is the current value of the outstanding debt? Is it selling at a premium or discount to par value? (Remember that coupon payments of 7% are made annually rather than the semiannually.)
- Based on Gentrix’s current capital structure, what is the firm’s weighted average cost of capital?
- Assume that Gentrix currently has a capital structure that is 80% equity and 20% debt. The firm has decided to issue debt to retire equity such that their resulting capital structure is 60% equity and 40% debt. The firm has determined that they can comfortably afford the higher debt levels without any material effect on their competitiveness or financial condition. Once the capital structure is changed, what is the cost of equity and what is the weighted average cost of capital? Does the value of the firm increase or decrease? Please explain.
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