Use the following information: Debt: $85,000,000 book value outstanding. The debt is trading at 85% of book value. The yield to maturity is 9%. Equity: 3,500,000 shares selling at $52 per share. Assume the expected rate of return on Federated’s stock is 18%. Taxes: Federated’s marginal tax rate is Tc = 0.21. Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later, its debt ratio is down to 12.50% (D/V = 0.1300). The interest rate has dropped to 8.6%. The company’s business risk, opportunity cost of capital, and tax rate have not changed.Use the three-step procedure to calculate Federated’s WACC under these new assumptions
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Use the following information:
- Debt: $85,000,000 book value outstanding. The debt is trading at 85% of book value. The yield to maturity is 9%.
- Equity: 3,500,000 shares selling at $52 per share. Assume the expected
rate of return on Federated’s stock is 18%. - Taxes: Federated’s marginal tax rate is Tc = 0.21.
Suppose Federated Junkyards decides to move to a more conservative debt policy. A year later, its debt ratio is down to 12.50% (D/V = 0.1300). The interest rate has dropped to 8.6%. The company’s business risk,
Use the three-step procedure to calculate Federated’s WACC under these new assumptions
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