Question

Below is the information on ABC company and its tax rate is at 25% .

(Yield to Maturity)	9%
(Number Common Stocks	20,000
(Price Per share)	$40
(Long-term debt)	400,000
(Book value per share)	$30
(Expected Rate of Return on Stock)	16%

Required :

1) Find the company cost of capital

2) Subsidiary company to ABC company , i.e. LZT Berhad book value is at RM25 per share and its trading price currently is RM50. The company’s balance sheet is showing RM30 billion in long-term debt and it’s the same as its current value. It has 600 million shares currently outstanding. What is its market debt to total value ratio?(Assuming there is not tax rate)

Answer 1

1. Company cost of capital=(weight of debt*after tax cost of debt)+(weight of common stock*cost of common stock)

after tax cost of debt=yield to maturity*(1-tax rate)=9%*(1-25%)=6.75%

Value of common stock= number of shares*price per share =20,000*40=800,000

Value of the debt=400,000

Total value=value of common stock+Value of debt=800,000+400,000=1,200,000

weight of common stock=Value of common stock/Total value=800,000/1,200,000=66.67%

weight of debt=400000/1200000=33.33%

Weighted average cost of capital (WACC)=(33.33%*6.75%)+(66.67%*16%)=12.92%

2. Value of common stock=number of shares*priceper share=600 million*50=30,000 million=30 billion

Value of debt is same as current value=30 billion

Total value=30+30=60 billion

market debt to total value=market value of debt/Total value=30/60=50% (0.5)