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Chapter 13

# CH.13 WACC -Solutions to Help Session Problems-1.docx

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3530 Help Session Questions – Ch. 13 WACC - SOLUTIONS 1. A company just paid a \$2.00 per share dividend on its common stock (Div0 = \$2.00). The dividend is expected to grow at a constant rate of 7 percent per year. The stock currently sells for \$42 a share. What is the common equity’s cost of capital? A) 5.10% B) 11.76% C) 11.98% D) 12.10% Solution D Div0 = \$2; Div1 = \$2 x 1.07 = \$2.14. re = Div1/P0 + g = \$2.14/\$42 + 7% = 12.10% 2. Hamil Inc.’s 8 percent coupon rate, semi-annually payment, \$1,000 par value bond, which matures in 20 years, currently sells at a price of \$686.86. The company’s tax rate is 40 percent. What is the firm’s component cost of debt for purposes of calculating the WACC? A) 6.11% B) 7.33% C) 7.56% D) 12.22% Solution B Inputs: n = 40; PV = -686.86; PMT = 40; FV = 1000 Output: I = 6.11% periodic rate YTM = 12.22% rd after-tax = 12.22 x (1 - T) = 12.22 x (1 - 0.4) = 7.33% 3. Halley Industries' preferred stock pays an annual dividend of \$3 per share. When issued, the shares sold for their par value of \$100 per share. What is the cost of preferred stock if the current price is \$85 per share? A) 3.00% B) 3.53% C) 4.00% D) 4.70% Answer B r = \$3 / \$85 = 3.53%. preferred 4. What is Billabong’s WACC based on following information? • Its capital structure consists of 40 percent debt and 60 percent common equity. • The company has 20-year bonds outstanding with a 9 percent annual coupon that are trading at par. • The company’s tax rate is 40 percent. • The risk-free rate is 5.5 percent. • The market risk premium is 5 percent. • The stock’s beta is 1.4 A) 8.31% B) 9.66% C) 11.10% D) 11.18% Solution B rd = 9% re = rf + beta x (rm - rf) re = 5.5% + 1.4 x 5% = 12.5%. WACC = wdrd(1 - T) + were WACC = 0.4 x 9% x (1 - 0.4) + 0.6 x 12.5% = 9.66% 5. The WACC for a firm with only debt and equity in its capital structure, a debt-to-equity-ratio of 3/2, 8% before-tax cost of debt, 15% cost of equity, and a 35% tax rate is: A) 7.02% B) 9.12% C) 10.80% D) 13.80% Solution B It is straightforward to find that the weights of debt and equity in the firm’s capital structure are 60% and 40%, respectively. So we have: WACC = 0.6 x 8% x (1 - 0.35) + 0.4 x 15% = 9.12% 6. A firm has a WACC of 12%. It is financed with 40% debt and 60% equity. The firm's before- tax cost of debt is 10% and its tax rate is 40%. If the firm's dividend growth rate is 8% and its current stock price is \$40, what is the value of the dividend the firm is expected to pay at the end of 1 year from now? A) \$2.60 B) \$3.20 C) \$4.25 D) Cannot be determined without additional information Solution B rd = 10% WACC = 12% =0.4 x 10% x (1 - 0.4) + 0.6 x re .60 x re = 12% - 2.40% re = 9.60%/.60 = 16% P0 = Div1/(re-g)  40 = DIV1/(16 - 8) DIV1 = \$40 x 8% = \$3.20 7. Given the following information, what is WBM Corporation's WACC? Com
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