Question

Question 1 The beta for the equity in Enough Corporation is 0.95. The market risk premium is 7 per cent, and the risk-free rate is 5 per cent. Enough has a target debt/equity ratio of 25 per cent. Its cost of debt is 9 per cent, before taxes. If the tax rate is 30 per cent, what is the WACC?

Question 2 On 11 May 2010, Chase Manhattan had an issue of preference shares that traded for $80 per share. If the face value of the issue was $100 per share, the dividend was $7.60 and the tax rate was 39 per cent in 1990 and it is now 30 per cent. What is Chase Manhattan's cost of preference shares?

Answer 1

)

after tax cost of debt , d= 9%*(1- tax) = 9*(1-0.30) = 6.3%

market risk premium , MRP = 7%

risk free rate , rf = 5%

debt/equity , D/E = 25% = 0.25

beta = b = 0.95

cost of equity , k = rf + ( b*MRP) = 5 + (0.95*7) = 5 + 6.65 = 11.65%

Debt to asset ratio , w1 = (D/E)/(1+(D/E)) = 0.25/(1+0.25) = 0.25/1.25 = 0.20

Equity to asset ratio , w2 = 1-w1 = 0.80

WACC = (w1*d) + (w2*k) = (0.2*6.3) + (0.8*11.65) = 1.26 + 9.32 = 10.58%

2)

dividend , d= 7.60

price of 1 preference share , p = 80

cost of preference share = d/p = 7.6/80 = 0.095 or 9.5%