Question

Johnson has a target capital structure of 60% common stock, 5% preferred stock and 35% debt. The firm’s cost of equity is 10%, its cost of preferred is 4% and the pretax cost of debt is 6%. If the tax rate is 34%, what is Johnson’s weighted average cost of capital?

Select one:

a. 7.59%

b. 5.55%

c. 8.30%

d. 5.48%

Zahn Enterprises pays $3 million annually to its bondholders and $7.5 million annual to its stockholders. The required rates of return are 9 percent and 15 percent, respectively, by the bondholders and stockholders. What is the value of Zahn Enterprises?

Select one:

a. $83.33 million

b. $1.40 million

c. $10.50 million

d. $16.66 million

Answer 1

WACC = Weight of Common Equity * Cost of Common Equity + Weight of Preferred Equity * Cost of Preferred Equity + Weight of debt * Pretax cost of debt * (1 - Tax rate)

WACC = (60% * 10%) + (5% * 4%) + (35% * 6% * (1 - 34%))

WACC = 6% + 0.2% + 1.386% = 7.586%

Hence, Wacc = 7.59% (Option A)

Q2.

Value of Enterprise = Value of Debt + Value of Equity

Value of Debt = Annual Interest/Required rate of Return = $3mil/9% = $33.33 mil

Value of Equity = Annual Payment/Required rate of Return = $7.5mil/15% = $50 mil

Hence, total value = $83.33 mil(Answer a)