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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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