Question

You have the following information about Burgundy Basins, a sink manufacturer.

Equity shares outstanding		20	million
Stock price per share	$	39
Yield to maturity on debt		7.5	%
Book value of interest-bearing debt	$	350	million
Coupon interest rate on debt		4.4	%
Market value of debt	$	245	million
Book value of equity	$	410	million
Cost of equity capital		11.8	%
Tax rate		35	%

Burgundy is contemplating what for the company is an average-risk investment costing $38 million and promising an annual ATCF of $4.9 million in perpetuity.

a. What is the internal rate of return on the investment? (Round your answer to 2 decimal places.)

b. What is Burgundy's weighted-average cost of capital? (Round your answer to 2 decimal places.)

Answer 1

a

IRR = ATCF/cost = 4.9/38=12.90%

b

MV of shares = price*shares = 20*39=780m

Total Capital value = Value of Debt + Value of Equity

=245+780

=1025

Weight of Debt = Value of Debt/Total Capital Value

= 245/1025

=0.239

Weight of Equity = Value of Equity/Total Capital Value

= 780/1025

=0.761

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 7.5*(1-0.35)

= 4.875

WACC=after tax cost of debt*W(D)+cost of equity*W(E)

WACC=4.88*0.239+11.8*0.761

WACC =10.15%