Adequate information:
Common stock outstanding
Book value per share
Current price per share
Book
Coupon rate of Bond I
Face value of Bond I
Selling rate of Bond I
Price of Bond I
Term duration of Bond I
Number of compounding periods in a year
Book value of Bond II
Coupon rate of Bond II
Face value of Bond II
Selling rate of Bond II
Price of Bond II
Term duration of Bond II
Number of compounding periods in a year
Beta of the stock
Risk-free rate
Market risk premium
Tax rate
To compute: WACC for company F.
Introduction: The Weighted average cost of capital (WACC) refers to the cost of capital from various sources such as common stocks, preferred stocks, bonds, etc.
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Corporate Finance
- You have the following information on a company on which to base your calculations and discussion: Cost of equity capital (rE) = 18.55% Cost of debt (rD) = 7.85% Expected market premium (rM –rF) = 8.35% Risk-free rate (rF) = 5.95% Inflation = 0% Corporate tax rate (TC) = 35% Current long-term and target debt-equity ratio (D:E) = 2:5 a. What are the equity beta (bE) and debt beta (bD) of the firm described above?[Hint: Assume that the above costs of capital have been generated by an appropriate equilibrium model.] b. What is the weighted-average cost of capital (WACC) for this firm at the current debt-equity ratio? c. What would the company’s cost of equity capital become if you unlevered the capital structure (i.e. reduced gearing until there is no debt)arrow_forwardSuppose there is a large probability that L will default on its debt. For the purpose of this example, assume that the value of Ls operations is 4 million (the value of its debt plus equity). Assume also that its debt consists of 1-year, zero coupon bonds with a face value of 2 million. Finally, assume that Ls volatility, , is 0.60 and that the risk-free rate rRF is 6%.arrow_forwardWhat happens to ROE for Firm U and Firm L if EBIT falls to $1,600? What happens if EBIT falls to $1,200? What is the after-tax cost of debt? What does this imply about the impact of leverage on risk and return?arrow_forward
- If the estimated return on a corporate bond is 8%, while the return on US Treasury bond is 3%. How much is the risk premium in this case? Hint: The risk premium is the compensation investors required to hold the risky asset. It equals the expected return on the risky investment minus the risk-free return.arrow_forwardInfosystems, Inc. has a debt/equity ratio = 2. The firm has a cost of equity of 12% and a cost of debt of 6%. Calculate the firm’s equity’s beta (β) after the target debt/equity ratio changes to 1.5. Assume that the cost of debt does not change. Ignore taxes and other market imperfections. The risk-free interest rate is 2% and the market risk premium is 7%.arrow_forwardYou have the following initial information on Financeur Co. on which to base your calculations and discussion for question 2): • Current long-term and target debt-equity ratio (D:E) = 1:3 • Corporate tax rate (TC) = 30% • Expected Inflation = 1.55% • Equity beta (E) = 1.6325 • Debt beta (D) = 0.203 • Expected market premium (rM – rF) = 6.00% • Risk-free rate (rF) =2.05% 2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyout of Financeur Co. to allow them to integrate production activities. The potential acquiring firm’s management has approached an investment bank for advice. The bank believes that the firm can gear Financeur Co. to a higher level, given that its existing management has been highly conservative in its use of debt. It also notes that the customer’s firm has the same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations. a) What would the required…arrow_forward
- You have the following initial information on Financeur Co. on which to base your calculationsand discussion for questions 1) and 2):• Current long-term and target debt-equity ratio (D:E) = 1:3• Corporate tax rate (TC) = 30%• Expected Inflation = 1.55%• Equity beta (E) = 1.6325• Debt beta (D) = 0.203• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) =2.05%1) The CEO of Financeur Co., for which you are CFO, has requested that you evaluate apotential investment in a new project. The proposed project requires an initial outlay of$7.25 billion. Once completed (1 year from initial outlay) it will provide a real net cashflow of $556 million in perpetuity following its completion. It has the same business riskas Financeur Co.’s existing activities and will be funded using the firm’s current target D:Eratio.a) What is the nominal weighted-average cost of capital (WACC) for this project?b) As CFO, do you recommend investment in this project? Justify your answer(numerically).arrow_forwardYou have the following initial information on Financeur Co. on which to base your calculationsand discussion for questions 2):• Current long-term and target debt-equity ratio (D:E) = 1:3• Corporate tax rate (TC) = 30%• Expected Inflation = 1.55%• Equity beta (E) = 1.6325• Debt beta (D) = 0.203• Expected market premium (rM – rF) = 6.00%• Risk-free rate (rF) =2.05%2) Assume now a firm that is an existing customer of Financeur Co. is considering a buyoutof Financeur Co. to allow them to integrate production activities. The potential acquiringfirm’s management has approached an investment bank for advice. The bank believesthat the firm can gear Financeur Co. to a higher level, given that its existing managementhas been highly conservative in its use of debt. It also notes that the customer’s firm hasthe same cost of debt as that of Financeur Co. Thus, it has suggested use of a target debtequity ratio of 2:3 when undertaking valuation calculations.a) What would the required rate of return…arrow_forwardConsider a two-date binomial model. A company has both debt and equity in its capital structure. The value of the company is 100 at Date 0. At Date 1, it is equally like that the value of the company increases by 20% or decreases by 10%. The total promised amount to the debtholders is 100 at Date 1. The riskfree interest rate is 10%. a. What are the possible payoffs to the equityholders at date 1? What kind of financial product has the same payoffs? Please describe the detailed characteristics of the financial product. b. What are the possible payoffs to the bondholders at date 1? Are they riskfree? What kind of financial product/portfolio has the same payoffs? Please describe the detailed characteristics of the financial product/portfolio.arrow_forward
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