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WACC, Repurchase of stock, Treasury bond, Stock price

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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?
b. price?
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?

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Solution Summary

There are answers to 5 questions on WACC, Repurchase of stock, Treasury bond, Stock price, Price of bonds

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Q1 - Plato Inc. expects to have net income of $5,000,000 during the next year. Plato target capital structure is 35 percent debt and 65 percent equity. The company director budgeting has determined that the optimal capital budget for the coming year is $6,000,000. If Plato follows a residual dividend policy to determine the coming years dividend, then what is Plato's payout ratio? Please calculating the earnings that must be retained to stay at the target ratio, the residual amount available for dividends and the payout ratios.

Q7 - A consultant has collected the following information regarding Young Publishing:

Total Assets $4,000 Millions Tax rate 40%
Operating income (EBIT) $300 millions Debt ratio 0%
Interest expense 0 millions WAAC 10%
Net income $180 millions Marker Book value 1.0% 1.00%
Share price $32 EPS = DPS $3.20

The company has no growth opportunities (g=0), so the company pays out all its earnings as dividends (EPS = DPS) Young's stock price can be calculated by simply dividing earnings per share by the require return on equity capital, which currently equals the WACC because the company has no debt.
The consultant believes that the company would be much better off it were to change its capital structure to 40 percent debt and 60 percent equity. After meeting with investment bankers, the consultant concludes that the company could issue $1,200 million of debts at a before tax cost of 7 percent, leaving the company with interest expense of $84 million. The $1,200 million raised from the debt issue would be used to repurchase stock at $32per share. The repurchase will have no effect on the firm's EBIT; however, after the repurchase, the cost of equity will increase to 11 percent. If the firm follows the consultant's advice, what will be its estimated stock price after the capital structure change? Please calculate the current number of shares outstanding currently, the number of shares outstanding after repurchase, the new EPS after repurchase, and the new stock price. Please show all work and calculations.

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