Finance

ASSIGNMENT 5

MGF 301

Corporation Finance

Spring 2013

1. The total book value of WTC’s equity is $70 million and book value per share outstanding is $10. The stock of WTC is currently selling for a price of $42 per share and the beta of WTC is 1.15. The bonds of WTC have a face value of $46 million and sell at a price of 110 percent of face value. The yield to maturity on the bonds is 5 percent and the firm’s tax rate is 35 percent. If the E(Rm) = 9% and Rf = 1%, calculate the WACC of WTC.

Number of shares outstanding = 70,000,000 book value/10 per share =

7,000,000 shares outstanding

Market Value of WTC = 42 per share x 7,000,000 shares = 294,000,000

Book Value of Debt = 46,000,000

Market Value of Debt = 46,000,000 x 1.10 = 50,600,000

Expected Return on Stock = .01 + 1.15(.09 - .01) = .102

WACC using market values of debt and equity:

Market WACC = (294M/344.6M) * .102 +(50.6M/344.6M) * (1-.35)*.05

Market WACC=0.08702263+0.14683691*.0325= 0.09179 or 9.18%

2. Suppose the company in #1 is considering the following expansion projects. How would you calculate the required rate of return to use in the NPV analysis of the following: Explain.

a) The company should only use the WACC here if the new product has the same beta risk as the company’s current product and the firm is financing the new project using the same mix of debt and equity as the overall firm. If this is not the case, the firm should find the risk of being in this particular business (i.e., find the βassets for the business) and use CAPM to find the discount rate

(b) The company should find the βassets of the new line of business and use CAPM to find the discount rate. WACC would not be appropriate here.

3. One year ago, an American investor bought 1000 shares of London Bridges at a price of £32 (or 32 UK pounds) per share when the exchange rate was $1.5/1£ (or $1.50 dollars = 1 pound). The investor also invested...