Question
A large industrial company has in recent years on average paid taxes worth 16% of its Earnings Before Taxes, but it is subject the current
A large industrial company has in recent years on average paid taxes worth 16% of its Earnings Before Taxes, but it is subject the current tax bracket of 21% on every dollar of additional earnings that it generates. The company is only financed with these two financial claims:
* 40 million bonds outstanding with $1,000 par value each, 4.2% coupons paid semiannually, 14 years to maturity, high investment grade rating, a quoted yield of 3.3%, and selling currently for 110.0% of par.
* 200 million shares of common stock selling for $370 per share with a 0.9 beta and 60% volatility.
In financial markets, the current risk-free interest rate is 1%, and equity investors expect a 4% market risk premium over safe investments.
a) What is the weight of the debt in the companys current capital structure? Answer should be up to 3 decimal places
b) What is the companys current after-tax cost of debt. Answer should be in percent
c) What is the expected return that equity investors currently require to invest in shares of this company? Answer should be in percent
d) Instead of using the previous answers from parts a-c above: The company targets 40% debt financing in its capital structure, with the remaining in common stock. The CFO believes that the (pre-tax) cost of the companys debt financing is 4% and that investors require an 8% return to buy its stock. The marginal tax rate is 21%. What is her estimate of the firms overall WACC? Answer should be in percent
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