1) Acetate, Inc., has equity with a market value of $20 million and debt with a market value of $10 million. The cost of the debt is 14 percent per annum. Treasury bills that mature in one year yield 8 percent per annum, and the expected return on the market portfolio over the next year is 18 percent. The beta of Acetate's equity is 0.9.The firm pays no taxes.
a. What is Acetate's debt-equity ratio?
b. What is the firm's weighted average cost of capital?
c. What is the cost of capital for an otherwise identical all-equity firm?
2) Rayburn Manufacturing is currently an all-equity firm. The firm's equity is worth $2 million. The cost of that equity is 18 percent. Rayburn pays no taxes.
Rayburn plans to issue $400,000 in debt and to use the proceeds to repurchase stock.
The cost of debt is 10 percent.
a. After Rayburn repurchases the stock, what will the firm's overall cost of capital be?
b. After the repurchase, what will the cost of equity be?
c. Use your answer to (b) to compute Rayburn's weighted average cost of capital after the repurchase. Is this answer consistent with (a)?
3) A10-year Treasury bond is issued with a face value of $1,000, paying interest of $60 a year. If market yields increase shortly after the T-bond is issued, what happens to the bond's:
a. coupon rate?
c. yield to maturity?
4) Company Z-prime is like Z in all respects (see question 7) save one: Its growth will stop after year 4. In year 5 and afterward, it will pay out all earnings as dividends. What is Z-prime's stock price? Assume next year's EPS is $15.
5) KIC, Inc., plans to issue $5 million of perpetual bonds. The face value of each bond is $1,000. The annual coupon on the bonds is 12 percent. Market interest rates on one-year bonds are 11 percent. With equal probability, the long-term market interest rate will be either 14 percent or 7 percent next year. Assume investors are risk-neutral.
a. If the KIC bonds are noncallable, what is the price of the bonds?
b. If the bonds are callable one year from today at $1,450, will their price be greater than or less than the price you computed in (a)? Why?
There are answers to 5 questions on WACC, Repurchase of stock, Treasury bond, Stock price, Price of bonds