Oglesby Industries currently finances operations using a financial structure that is one hundred percent equity, with a required return on assets of 14 percent. Due to the recent economic downturn, all corporate and personal income taxes have been eliminated and replaced with direct taxes on the consumption of goods and services (so that taxes do not affect either valuation or the cost of capital). Security analysts estimate that there is a .40 probability that the value of Oglesby Industries will be $39 million at the end of one year, but that there is a .60 percent probability that the firm will be worth only $12 million at year end.
(a) Determine the current value of Oglesby Industries
(b) Assuming that Oglesby Industries is recapitalized through the issuance of risk free zero coupon bonds having one year to maturity, an annualized yield to maturity of 8 percent, and a face value (promised payment) of $12 million, determine both the costof equity capital and the weighted average cost of capital for Oglesby Industries.
(c) Assuming that Oglesby Industries is recapitalized through the issuance of risky debt (this debt is not risk free debt as in part b) having a promised date 1 payment of $20 million, determine both the promised yield and expected return for the risky bonds, as well as the cost of equity and the weighted average cost of capital for Oglesby.