Question

# ABC's current book value capital structure is: Bonds \$40 million (Number of bonds outstanding= 40,000) (Coupon...

ABC's current book value capital structure is: Bonds \$40 million (Number of bonds outstanding= 40,000) (Coupon rate= 10% per annum) (Coupon payments annual, the face value= \$1,000) (Remaining maturity= 16 years) Common Stock \$50 million (Number of shares outstanding= 2million) Retained earnings \$10 million The current yield to maturity of the firm's bonds is 7%. The current dividends per share= \$2.5 and the growth rate of the dividends stream is 4% per annum and into indefinite future. The current required expected rate of return on the firm's common stock is 11% per annum. The corporate tax rate is 0.3. Using the market value weights, calculate the weighted average cost of capital of ABC Ltd.

Current Market Of Stock:

pE = D1/(rE - g) = [\$2.5 x 1.04] / [0.11 - 0.04] = \$2.6 / 0.07 = \$37.14

Market Value of Equity = [Current Market Price x No. of stocks outstanding] + Retained Earnings

= [\$37.14 x 2,000,000] + \$10,000,000 = \$74,285,714.29 + \$10,000,000 = \$84,285,714.29

To find the current market price of the bond, we need to put the following values in the financial calculator:

 INPUT 16 7 10*1,000=100 1,000 TVM N I/Y PV PMT FV OUTPUT -1,283.40

So, Market Value of Debt = [Current Market Price x No. of bonds outstanding]

= \$1,283.40 x 40,000 = \$51,335,978.32

Total Market Value = \$84,285,714.29 + \$51,335,978.32 = \$135,621,692.60

wD = Market Value of Debt / Total Market Value = \$51,335,978.32 / \$135,621,692.60 = 37.85%

wE = Market Value of Equity / Total Market Value = \$84,285,714.29 / \$135,621,692.60 = 62.15%

WACC = [wD x kD x (1 - t)] + [wE x kE] = [0.3785 x 7% x (1 - 0.30)] + [0.6215 x 11%] = 2.65% + 6.84% = 9.49%