Question

Peace Waterfront Ltd currently has 1.2 million ordinary shares outstanding and the share has a beta of 2.2. It also has $10 million face value of bonds that have 5 years remaining to maturity and 8% coupon rate with semi-annual payments, and are priced to yield 13.65%. If Peace Waterfront issues up to $2.5 million of new bonds, the bonds will be priced at par and have a yield of 13.65%; if it issues bonds beyond $2.5 million, the expected yield on the entire issuance will be 16%. Peace Waterfront has learned that it can issue new ordinary shares at $10 a share. The current risk-free rate of interest is 3% and the expected market return is 10%. Peace Waterfront’s marginal tax rate is 30%. Compute the market value for both bond and equity.

If Peace Waterfront intends to raise $7.5 million of new capital while maintaining the same debt-to-equity ratio as above, compute its weighted average cost of capital (WACC).

Can Peace Waterfront use the WACC computed for all of its future investment projects? Why?

Answer 1