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3PracticeAnswers - Optional Practice Questions Class 14...

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Optional Practice Questions Class 14 ANSWERS Practice Question #1 Delta Corp. has a current capitalization of $1 million with a debt-to-equity 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 = �������� ���� = �� , ��� ��� , ��� = .05 = 5% Using MM Prop2, the Cost of Equity is: 𝑟 = 𝑟 + ( 𝑟 − 𝑟 ) = .13 + (. 13 .05). 55 = .1740 = 17.4% Putting all the components together: 𝑊𝐴𝐶𝐶 = .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 1-year T-bills are yielding 5%), what is their new WACC?
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