Ch 8 B10_Correct

Ch 8 B10_Correct - 9.2238 ; After-tax rd = (1 - 0.40)...

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Hey Professor G, I have found a mistake in the solutions. Problem B10 (Estimating the WACC) in Chapter 8: Company has 10,000 bonds and 400,000 shares outstanding. The bonds have a 10% annual coupon, $1000 face value, $1050 market value, and 10 years to maturity. The beta on the stock is 1.3 and its price per share is $40. The risk-less return is 6%, the expected market return is 14%, and the Frm ʼ s tax rate is 40%. a) what is the after tax cost of debt Fnancing? b) what is the after tax cost of equity Fnancing? c) what is the WACC Debt summary: Equity summary: 10,000 bonds 400,000 shares outstanding $1000 face value 1.30 stock beta $1050 market value $40 per share 10% annual coupon 6% = rf 10 years to maturity (n) 14% = rm 40% tax rate Book Solution: a. CALC: n = 20 PV = -$1,050 PMT = (10% x $1,000) / 2 = $50 ±V = $1,000 r = 4.6119% YTM = 2 x r =
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Unformatted text preview: 9.2238 ; After-tax rd = (1 - 0.40) 9.22238% = 5.5342% b. re = rf + β (rM - rf) = 6% + 1.30(14% - 6%) = 16.40% c. L = D / (D + E) = 10,000 x $1,050 / (10,000 x $1,050 + 400,000 x $40) = 0.3962 WACC = (1 - L)re + L(1 - T)rd = (1 - 0.3962)16.40% + 0.3962(1 - 0.40) 9.21% = 12.09% Correct Solution: a. CALC : n=10 PV= -$1050 PMT= (10% * $1000)= $100 ±V = $1,000 r = 9.2136 After-tax rd= (1-.40)9.2136= 5.5281% b. re = rf + β (rM - rf) = 6% + 1.30(14% - 6%) = 16.40% c. L = D / (D + E) = 10,000 x $1,050 / (10,000 x $1,050 + 400,000 x $40) = 0.3962 WACC = (1 - L)re + L(1 - T)rd = (1 - 0.3962)16.40% + 0.3962(1 - 0.40) 9.2136 = 12.092 Conclusions: The book solved the problem as if the bond had semi annual coupons when indeed the problem states annual coupons. The end result in the WACC is very small, but there is a difference....
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This note was uploaded on 09/18/2011 for the course FIN 303 taught by Professor Bernile during the Spring '11 term at University of Miami.

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Ch 8 B10_Correct - 9.2238 ; After-tax rd = (1 - 0.40)...

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