WACCHWkey - $ = + - = equity C debt r V E ) T 1 ( r V D...

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Solutions to Chapter 12 Homework Weighted Average Cost of Capital and Company Valuation 8. The rate on Buildwell’s debt is 5 percent. The cost of equity capital is the required rate of return on equity, which can be calculated from the CAPM as follows: 4% + (0.90 × 8%) = 11.2% The weighted average cost of capital, with a tax rate of 40%, is: × + - × × = equity C debt r V E ) T 1 ( r V D WACC = [0.30 × 5% × (1 – 0.40)] + [0.70 × 11.2%] = 8.74% 9. The internal rate of return, which is 12%, exceeds the cost of capital. Therefore, BCCI should accept the project. The present value of the project cash flows is: $100,000 × annuity factor(8.74%, 8 years) = 94 . 870 , 558 $ ) 0874 . 1 ( 0.0874 1 0.0874 1 $100,000 8 = × - × This is the most BCCI should pay for the project. 11. Security Market Value Explanation Debt $ 5.5 million 1.10 × par value of $5 million Equity $15.0 million $30 per share × 500,000 shares * Total $20.5 million *Number of shares = 000 , 500 share per book value 20 $ book value million 10
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Unformatted text preview: $ = + - = equity C debt r V E ) T 1 ( r V D WACC % 42 . 12 % 15 5 . 20 15 ) 40 . 1 ( % 9 5 . 20 5 . 5 = + - = 12-1 13. The 12.5% value calculated by the analyst is the current yield of the firms outstanding debt: interest payments/bond value. This calculation ignores the fact that bonds selling at discounts from, or premiums over, par value provide expected returns determined in part by expected price appreciation or depreciation. The analyst should be using yield to maturity instead of current yield to calculate cost of debt. [This answer assumes the value of the debt provided is the market value. If it is the book value, then 12.5% would be the average coupon rate of outstanding debt, which would also be a poor estimate of the required rate of return on the firms debt.] 12-2...
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This note was uploaded on 10/28/2010 for the course FIN 3300 taught by Professor Jerry during the Winter '10 term at CSU East Bay.

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WACCHWkey - $ = + - = equity C debt r V E ) T 1 ( r V D...

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