Fin550Midterm_2015_KEY.pdf

Remember the cost of equity for the division will

• Test Prep
• 28

This preview shows page 15 - 17 out of 28 pages.

Subscribe to view the full document.

16 9. At its target capital structure, what is the WACC for the firm as a whole? (20 points) The weighted average cost of capital (WACC) is defined as: (1 ) d e D E WACC R R V V where D represents the market value of debt, E is the market value of equity, V is the market value of the firm (debt plus equity), R d is the cost of debt, R e is the cost of equity, and τ is the corporate tax rate. Let’s determine each component in turn. To get the capital structure weights, we need the market values of debt and equity. In Exhibit 3.1., we have the market value of equity is \$4,500 million, and we know that the market value of debt is \$1,500 million. The value of the firm V is just the sum of the debt and equity: \$1,500 + \$4,500 = \$6,000 million. With that, we know that the capital structure weights are: 1,500 4,500 0.25 0.75 6,000 6,000 D E V V We are also told in Exhibit 3.1. that the applicable tax rate is 40%. Hence, all that is left to do is to determine the cost of debt and the cost of equity. As we saw with the Roche case, there are several ways to estimate the firm’s cost of debt. Ideally we would determine the yield to maturity (YTM) on the firm’s own bonds. If that is not available, we could use the YTM of bonds of comparable firms, or use Treasuries as a benchmark and add a spread to account for the bond’s risk.

{[ snackBarMessage ]}

What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern