CH 13 - HW PROBLEM SOLUTIONS - 1 CHAPTER 13 PROBLEMS WACC Calculations Example 13-1(page 561 2 The Aztec Corporation has the following capital

# CH 13 - HW PROBLEM SOLUTIONS - 1 CHAPTER 13 PROBLEMS WACC...

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1 C H A P T E R 1 3 : P R O B L E M S WACC Calculations: Example 13-1 (page 561) 2. The Aztec Corporation has the following capital components and costs. Calculate Aztec's WACC. Component Value Cost Debt \$23,625 12.0% Preferred Stock \$ 4,350 13.5% Common Equity \$52,275 19.2% SOLUTION: Component Value Weights Cost Factors Debt \$23,625 .294 12.0% 3.53 Preferred Stock \$ 4,350 .054 13.5% .73 Common Equity \$52,275 .652 * 19.2% 12.52 \$80,250 1.000 16.78 Use WACC = 16.8% *Rounding sometimes causes the weights to sum to a figure slightly different from 1.000. When that happens we generally round one figure the wrong way to show weights that add to exactly 1.000. 3. Willerton Industries Inc. has the following balances in its capital accounts as of 12/31/x3: Long Term Debt \$65,000,000 Preferred Stock \$15,000,000 Common Stock \$40,000,000 Paid in Excess \$15,000,000 Retained Earnings \$37,500,000 Calculate Willerton’s capital structure based on book values. SOLUTION (\$M) % Debt \$65.0 37.7 Preferred Stock 15.0 8.7 Equity 92.5 53.6 Total \$172.5 100.0
2 Market Value Based Capital Structure: Example 13-2 (page 564) 4. Referring to Willerton Industries of the previous problem, the company’s long term debt is comprised of 20-year \$1,000 face value bonds issued seven years ago at an 8% coupon rate. The bonds are now selling to yield 6%. Willerton’s preferred is from a single issue of \$100 par value, 9% preferred stock that is now selling to yield 8%. Willerton has four million shares of common stock outstanding at a current market price of \$31. Calculate Willerton’s market value based capital structure. SOLUTION: a. Market value of debt : n = 13 x 2 = 26 FV = 1,000 I/Y = 6/2 = 3 PMT = 1,000 x 8%/2 = 40 PV = ? = 1,178.77 Market value of preferred stock Number of preferred shares from previous problem \$15M/\$100 = 150,000 \$9/.08 = \$112.50 Total market values Market Value % Debt \$1,178.77 x 65,000 \$76,620,050 35.2 Preferred stock \$112.50 x 150,000 16,875,000 7.8 Equity \$31 x 4,000,000 124 ,000,000 57.0 \$217,495,050 100.0 5. Again referring to Willerton of the two previous problems, assume the firm’s cost of retained earnings is 11% and its marginal tax rate is 40%, calculate its WACC using its book value based capital structure ignoring floatation costs. Make the same calculation using the market value based capital structure. How significant is the difference? SOLUTION: Book Value Debt .377 x 6.0% x (1 - .4) 1.36 Preferred .087 x 8% .70 Equity .536 x 11% 5.90 WACC 7.96% Market Value Debt .352 x 6.0% x (1 - .4) 1.27 Preferred .078 x 8% .62 Equity .57 x 11% 6.27 WACC 8.16% In this case, WACCs based on book and market values are only 0.2% apart, a relatively insignificant difference.
The Cost of Capital Cost of Debt: Example 13-3 (page 567) 11. The Dentite Corporation’s bonds are currently selling to yield new buyers a 12% return on their investment. Dentite’s marginal tax rate including both federal and state taxes is 38%. What is the firm’s cost of debt? SOLUTION : The cost of debt is the return received by investors reduced by the company’s tax savings due to the fact that interest is tax deductible.

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