Solutions to Chapter 12
Weighted Average Cost of Capital and Company Valuation
1.
The yield to maturity for the bonds (since maturity is now 19 years) is the interest
rate (r) that is the solution to the following equation:
[$80
×
annuity factor(r, 19 years)] + [$1,000/(1 + r)
19
] = $1,050
050
,
1
$
)
r
1
(
000
,
1
$
r)
(1
r
1
r
1
$80
19
19
=
+
+
+
×

×
⇒
r = 7.50%
Using a financial calculator, enter: n = 19, FV = 1000, PV = ()1050, PMT = 90,
and then compute i = 7.50%
Therefore, the aftertax cost of debt is: 7.50%
×
(1 – 0.35) = 4.88%
2.
%
0
.
10
100
.
0
40
$
4
$
P
DIV
r
0
=
=
=
=
3.
×
+
×
+

×
×
=
equity
preferred
C
debt
r
V
E
r
V
P
)
T
1
(
r
V
D
WACC
= [0.3
×
7.50%
×
(1 – 0.35)] + [0.2
×
10%] + [0.5
×
12.0%] = 9.46%
4.
%
75
.
13
1375
.
0
05
.
0
60
$
05
.
1
5
$
g
P
)
g
1
(
DIV
g
P
DIV
r
0
0
0
1
=
=
+
×
=
+
+
=
+
=
5.
The total value of the firm is $80 million.
The weights for each security class
are as follows:
Debt:
D/V = 20/80 = 0.250
Preferred:
P/V = 10/80 = 0.125
Common:
E/V = 50/80 = 0.625
×
+
×
+

×
×
=
equity
preferred
C
debt
r
V
E
r
V
P
)
T
1
(
r
V
D
WACC
= [0.250
×
6%
×
(1 – 0.35)] + [0.125
×
8%] + [0.625
×
12.0%] = 9.475%
121
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Executive Fruit should use the WACC of Geothermal, not its own WACC,
when evaluating an investment in geothermal power production.
The risk of
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 Winter '07
 Tennyson
 Finance, Annuity, Corporate Finance, Cost Of Capital, Interest, Interest Rate, Net Present Value, Valuation, Weighted average cost of capital, weighted average cost

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