Question 1. A firm has a capital structure containing 60 percent debt and 40 percent common stock equity. Its outstanding bonds offer investors a 6.5 percent yield to maturity. The risk-free rate currently equals 5 percent, and the expected risk premium on the market portfolio equals 6 percent. The firm's common stock beta is 1.20.
a. What is the firm's required return on equity?
b. Ignoring taxes, use your finding in part (a) to calculate the firm's WACC.
c. Assuming a 40 percent marginal tax rate, recalculate the firm's WACC found in part (b)
d. Compare and contrast the values for the firm's WACC found in parts (b) and (c).
Question 2. A firm has a capital structure containing 40 percent debt, 20 percent preferred stock, and 40 percent common stock equity. The firm's debt has a yield to maturity of 8.1 percent, its preferred stock's annual dividend is $3.10, and the preferred stock's current market price is $50.00 per share. The firm's common stock has a beta of 0.90, and the risk-free rate and the market return are currently 4.0 percent and 13.5 percent, respectively. The firm is subject to a 40 percent marginal tax rate.
a. What is the firm's cost of preferred stock?
b. What is the firm's cost of common stock?
c. Calculate the firm's after-tax WACC.
d. Recalculate the firm's WACC, assuming that its capital structure is deleveraged to contain 20 percent debt, 20 percent preferred stock, and 60 percent common stock.
e. Compare, contrast, and discuss your findings from parts (c) and (d).