A corporation has 11,000,000 shares of stock outstanding at a price of $40 per share. They just paid a dividend of $2 and the dividend is expected to grow by 4% per year forever. The stock has a beta of .8, the current risk free rate is 3%, and the market risk premium is 6%. The corporation also has 200,000 bonds outstanding with a price of $1,100 per bond. The bond has a coupon rate of 7% with semiannual interest payments, a face value of $1,000, and 13 years to go until maturity. The company plans on issuing debt until they reach their target debt ratio of 60%. They expect their cost of debt to be 8% and their cost of equity to be 11% under this new capital structure. The tax rate is 40%
1. What is their WACC using their target capital structure and expected costs of debt and equity under the target capital structure?
a) 7.3% b) 7.8% c) 8.4% d) 9.2%
2. Given the new cost of debt, what should be the new price of the bond?
a) $920 b) $1,060 c) $1,137 d) $1,239
3. Given the new cost of equity, what should be the new price of the stock?
a) $30 b) $37 c) $44 d) $52