chap012solutions - Solutions to Chapter 12 Weighted Average...

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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 after-tax 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% 12-1
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6. Executive Fruit should use the WACC of Geothermal, not its own WACC, when evaluating an investment in geothermal power production. The risk of the project determines the discount rate, and in this case, Geothermal’s WACC is more reflective of the risk of the project in question.
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