sol2_456-4

# sol2_456-4 - Problem Set 2 Solutions Exercise 1 Parts a and...

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Problem Set 2: Solutions Exercise 1 Parts a and b (with MV of equity = 750 and MV of debt = 500) Cost of equity 10% MV of equity 750 After tax cost of debt 5% MV of debt 500 =BV weight of debt 0.4 WACC 8.00% FCFF 100 Firm value 1250 - Debt value 500 Equity value 750 FCFF 100 - interest (1-t) 25 FCFE 75 Equity value 750 Part c (with MV of equity = 850 and MV of debt = 500) Cost of equity 10% MV of equity 850 After tax cost of debt 5% MV of debt 500 weight of debt 0.37037 WACC 8.15% FCFF 100 Firm value 1227.273 - Debt value 500 Equity value 727.2727 FCFF 100 - interest (1-t) 25 FCFE 75 Equity value 750 Part d The problem is that the market values of equity and debt in the WACC calculation do not match the estimated values of debt and equity. If you want convergence, you need to replace the market values of equity and debt in the WACC calculation by their estimated values to compute the weights. The valuations will only converge if both the equity and the debt are correctly valued. Does this happen in practice? Yes, almost every single time: in computing the WACC, we

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sol2_456-4 - Problem Set 2 Solutions Exercise 1 Parts a and...

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