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Unformatted text preview: Optional Practice Questions Class 14 ANSWERS Practice Question #1 Delta Corp. has a current capitalization of $1 million with a debttoequity ratio of .55 and an ROA of 13%. Their interest payment on their current debt is $17,740 per year and they have a 40% corporate tax rate. a. What is Delta’s current weighted average cost of capital? First compute the weights of debt and equity (I start with debt): If $1million – Amount of Debt = Amount of Equity, then $ ¡¢£¤¥ = .55 ⇒ 1.55D = $550,000 ⇒ Debt = $354,839 and Equity = $645,161 ($1million – $354,839) Next compute the Cost of Debt: r ¦ = §¨©ª«ª¬© ª© = ¡® , ®¯° ±²¯ , ³±´ = .05 = 5% Using MM Prop2, the Cost of Equity is: µ = ¶ + ( ¶ − · ) ¸ ¹ = .13 + (. 13 − .05). 55 = .1740 = 17.4% Putting all the components together: = .174 ∗ 645,161 1,000,000 + .05 ∗ 354,839 1,000,000 ∗ (1 − .40) = .1229 = 12.29% b. If Delta needs to expand at a cost of $500,000 and funds the expansion with bonds at 8% interest (current 1year b....
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This note was uploaded on 10/28/2011 for the course FIN 321 taught by Professor Smith during the Fall '08 term at University of Illinois at Urbana–Champaign.
 Fall '08
 SMITH
 Debt, Interest

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