Question

Easy Car Corp. is a grocery store located in the Southwest. It expects to pay an annual dividend of ?$6.30 next year to its shareholders and plans to increase the dividend annually at the rate of 5.0?% forever. It currently has 600,000 common shares outstanding. The shares currently sell for ?$60 each. Easy Car Corp. also has 20,000 semiannual bonds outstanding with a coupon rate of 8.9141?%, a maturity of 26 ?years, and a par value of ?$1,000. The bonds currently have a yield to maturity? (YTM) of 10%. The corporate tax rate is 20 ?%?

1. What is the cost of debt for Easy Corp.?

2. How many interest payments are left for the bond of Easy Corp.?

3. What is the interest payment per period for the bond? Round to two decimals

4. What is the discount rate per period to use in pricing the bonds?

5. What is the market value of equity for the calculation of the WACC for Easy? Round to the nearest dollar (no decimals)

6. What is the cost of equity for Easy? TWO decimal places

7. What is the market value of debt to be used in the calculation of the WACC for Easy? Round to the nearest dollar (no decimals)

8. What is the value of E/V? TWO decimal places

9. What is weighted average cost of capital (WACC) for Easy Corp.? TWO decimal places

Answer 1

1) Cost of debt = YTM = 10%

2) No. of semi-annual interest payments left = 26 x 2 = 52

3) Semi-annual Interest payment = 1,000 x 8.9141% / 2 = $44.57

4) Discount rate per period = YTM / 2 = 5%

5) Market Value of equity = 600,000 x 60 = 36,000,000

6) Cost of equity, re = D1 / P + g = 6.30 / 60 + 5% = 15.50%

7) Bond Price can be calculated using PV function

N = 26 x 2 = 52, PMT = 44.57, FV = 1000, I/Y = 5% => Compute PV = $900.00

Market Value of debt = 900 x 20,000 = 18,000,000

8) E/V = 36 / (18 + 36) = 66.67%

9) WACC = E/V x re + D/V x YTM x (1 - tax)

= 66.67% x 15.50% + 33.33% x 10% x (1 - 20%)

= 13.00%