Question

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $25 million in new projects. The firm's present market value capital structure, here below, is considered to be optimal. There is no short-term debt. Debt $30,000,000 Common equity 30,000,000 Total capital $60,000,000 New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so the dividend yield is $1.20/$30 = 4%.) The marginal tax rate is 35%. In order to maintain the present capital structure, how much of the new investment must be financed by common equity?

Enter your answer in dollars. For example, $1.2 million should be entered as $1200000.

$

Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC? Round your answer to two decimal places. %

Answer 1

a.) Weight of Equity = Equity/Total Capital

Equity =$30,000,000

Total Capital =60,000,000

Weight of Equity =50.00%

Investment to be financed by CE =$12,500,000

b) WACC = (Weight of Equity x Cost of Equity) + (Weight of Debt x After Tax Cost of Debt)

D₁ = $1.20

P₀ = $30

g = 8%

Cost of equity = D1 / P0 + g

= 1.2 / 30 + 0.08

= 12.00%

Weight of debt =50%

After Tax Cost of Debt = 8% * (1-0.35) = 5.20%

WACC = (Weight of Equity x Cost of Equity) + (Weight of Debt x After Tax Cost of Debt)

WACC = 0.50 * 12 + 0.50 * 5.2

= 8.60%