A summary of the balance sheet of Travellers Inn Inc. (TII), a company which was formed by merging a number of regional motel chains and which hopes to rival Holiday Inn on the national scene, is as follows:
Travellers Inn Inc.
Balance Sheet
December 31, 2012 (Millions of Dollars)
Cash $ 10 Accounts payable $ 10
Accounts receivable 20 Accruals 10
Inventories 20 Short-term debt 10
Current Assets $ 50 Current liabilities $ 30
Net fixed assets 50 Long-term debt 30
Common stock 10
Retained earnings 30
Total assets $100 Total liabilities & equity $100
Consider the following facts for TII:
(1) Short-term bank debt currently costs 6 percent and it is used to finance receivables and inventories on a seasonal or temporary basis.
(2) Long-term debt consists of 20-year, semiannual payment mortgage bonds, each with a face value of $1,000 and an annual coupon rate of 8 percent. Currently, these bonds provide investors a yield-to-maturity of 9 percent.
(3) The company has 4 million shares of common stock outstanding at a current market price of $15 per share. Its equity beta is 1.5, the Treasury bond rate is 3 percent and the market risk premium is 7 percent.
(4) TII is in the 40 percent federal-plus state marginal tax bracket.
Estimate the company's weighted average cost of capital (WACC) using market value capital structure weights.