Accounting Company Position

FI-516 – WEEK 2 - HOMEWORK ASSIGNMENT

PROBLEM BASED ON CHAPTER 15 – WACC AND THE HAMADA FORMULA

Bickley Engineering Company has a capital structure of 30% Debt and 70% Equity. Its current Beta is 1.3, and its Market Risk Premium is 7.5% Points. The current Risk Free Rate is 3.5%. Bickley’s marginal tax rate is 40%.

What is the Unlevered Beta of Bickley? bU = b/[1 + (1 - T)(D/S)]. 1.3/(1.60)(.430)=1.91

Bickley’s management would like to change its capital structure to 15% Debt and 85% equity by retiring its bonds yielding 8%. The remaining long term debt will be at 7%. The marginal tax rate will remain the same.

What will be Bickley’s new Beta with this new 15/85 capital structure? b = bU[1 + (1 - T)(D/S)]. 1.91(1.6)(.17)=.51

What is the WACC (Weighted Average Cost of Capital) of Bickely with its 30/70 capital structure? Bickley’s average borrowing rate with this capital structure is 7.5%.

What will be Bickley’s WACC with 49%its 15/85 capital structure? WACC = wd(1 - T)rd + wsrs Wacc=.3(1.6).3+.72 WACC=49%

PROBLEM BASED ON CHAPTER 26 – MODIGLIANI & MILLER EXTENSION MODELS WITH GROWTH ASSUMPTIONS

Yancey Industries’ Free Cash Flow for the past 12 months is $2.0 Million, and the future expected growth rate of this FCF is 6.5%. Yancey has no debt in its current capital structure. Its Cost of Equity is 11.5%. Its tax rate is 35%. (Hint use Equations 26-16 and 26-17 from the textbook.)

Calculate the Unlevered Value of Yancey (Vu). VU = = = $3,571,429

Calculate VL and rsL for the scenario whereby Yancey uses $8.0 Million Debt costing 8%. Vl= VU+TD. rsL=

Using the Unlevered Value from above calculate VL and rsL by using the M&M Model (with taxes) for Yancey using $8.0 Million Debt costing 8%.