Four questions:
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1. Company A has beta of 1.7, debt/assets ratio of 20%, a tax rate of 34%, a cost of debt of 9%, and a cost of equity of 15%. The riskless rate is 4%. Find the WACC of Company A. If its debt/assets ratio is increased to 25% while its cost of debt remains unchanged, what is the new WACC? Which leverage ratio is better?
2. Company A has the following capital structure: $100 million in bonds selling at par with coupon 5%; 50 million shares of common stock priced at $25 each; and 1.5 million shares of preferred stock with an annual dividend of $3.00 each. Next year, Company A expects to have EBIT of $70 million out of which it wants to keep $10 million in retained earnings. The tax rate of Company A is 35%. Find the dividend that it should declare on the common stock. What is the dividend yield of this stock?
3. Company A has a debt/assets ratio of .27, beta of 1.35, cost of debt of .10, and income tax rate of .34. Company B has a debt/assets ratio of .30, an unknown beta, cost of debt of .08, and income tax rate of .32. Both companies are hotel chains. At the present, the risk-free rate is .031 and the expected return on the market is .11. Find the WACC for Company B.
4. Company A is a chemical company that has debt of $30, equity of $110, beta of 1.35, cost of debt of .11, cost of equity of .15, and income tax rate of .35. Company B is a retail store that has debt of $20, equity of $85, cost of debt of .09, cost of equity of .11, and income tax rate of .33. Both companies are hotel chains. At the present, the risk-free rate is .025 and the expected return on the market is .09. If Company A wants to start a retail store chain as a side business, using its existing capital, what is the minimum acceptable rate of return on the new venture? Which is the riskier business -chemicals or retail stores?