In both problems, use a market risk premium of 5.5% Problem 1 Terck Inc., a leading pharmaceutical company, currently has a balance sheet that is as follows: Liability Assets LT Bonds $900 Fixed Assets 1700 Equity $1800 Current Assets 1000 Total $2700 Total 2700 The firm's income statement looks as follows: Revenues COGS Depreciation EBIT LT Interest EBT Taxes Net Income 1000 400 100 500 100 400 200 200 The firm's bonds are all 20-year bonds with a coupon rate of 10% which are selling at 90% of face value (the yield to maturity on these bonds is 11%). The stocks are selling at a PE ratio of 9 and have a beta of 1.25. The six-month T.Bill rate is 6%. a. What is the firm's current cost of equity? b. What is the firm's current after-tax cost of debt? c. What is the firm's current weighted average cost of capital? CONT. PROBLEM 1 Assume that management of Terck Inc., which is very conservative, is considering doing an equity-for-debt swap (i.e. issuing $200 more of equity to retire $200 of debt). This action is expected to lower the firm's interest rate by 1%. d. What is the firm's new cost of equity? e. What is the new WACC? f. What is the change in the firm's value? In both problems, use a market risk premium of 5.5% Problem 1 Terck Inc., a leading pharmaceutical company, currently has a balance sheet that is as follows: Liability Assets LT Bonds $900 Fixed Assets 1700 Equity $1800 Current Assets 1000 Total $2700 Total 2700 The firm's income statement looks as follows: Revenues COGS Depreciation EBIT LT Interest EBT Taxes Net Income 1000 400 100 500 100 400 200 200 The firm's bonds are all 20-year bonds with a coupon rate of 10% which are selling at 90% of face value (the yield to maturity on these bonds is 11%). The stocks are selling at a PE ratio of 9 and have a beta of 1.25. The six-month T.Bill rate is 6%. a. What is the firm's current cost of equity? b. What is the firm's current after-tax cost of debt? c. What is the firm's current weighted average cost of capital? CONT. PROBLEM 1 Assume that management of Terck Inc., which is very conservative, is considering doing an equity-for-debt swap (i.e. issuing $200 more of equity to retire $200 of debt). This action is expected to lower the firm's interest rate by 1%. d. What is the firm's new cost of equity? e. What is the new WACC? f. What is the change in the firm's value