Problem
Use the following information for questions. A corporation has 20,000,000 shares of stock outstanding at a price of $50 per share. They just paid a dividend of $2 and the dividend is expected to grow by 5% per year forever.
The stock has a beta of .9, the current risk free rate is 3%, and the market risk premium is 6%. The corporation also has 400,000 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 70%.
They expect their cost of debt to be 8% and their cost of equity to be 13% under this new capital structure. The tax rate is 40%
1. What is the required return on the corporation's stock?
a) 7.9% b) 8.4% c) 8.9% d) 9.2%
2. What is the expected return on the corporation's stock?
a) 7.9% b) 8.4% c) 8.9% d) 9.2%
3. What is the yield to maturity on the company's debt?
a) 5.9% b) 6.15% c) 6.4% d) 6.75%
4. What percent of their current market value capital structure is made up of equity?
a) 35% b) 44% c) 58% d) 70%
5. What is their WACC using their target capital structure and expected costs of debt and equity?
a) 7.25% b) 7.5% c) 7.85% d) 8.1%
6. Given the new cost of debt, what should be the new price of the bond?
a) $920 b) $1,060 c) $1,172 d) $1,268
7. Given the new cost of equity, what should be the new price of the stock?
a) $21.75 b) $26.25 c) $31 d) $37.50