QUESTION 2

a) You are given the following data about ABC corporation, a multi-sector company: The companys estimated beta is 1.3

The market risk premium: 15%

There are 12 million common shares outstanding. The market value per share is $45

Yield on a risk-free short-term government bond is 1.2%

The company has two outstanding bond issues as follows:

o Issue 1: face value is $1000. Its current market price is 93.2% of par value. There are 250,000 bonds outstanding. The remaining maturity is 4 years. Coupon annual rate is 6% per annum. Coupon payment frequency is semiannual.

o Issue 2: par value is $1000. The bond market price is 107.3%. The bond expires in 10 years. There are 60,000 bonds outstanding. Coupon annual rate is 7%. Coupon payment frequency is annual.

The company doesnt issue preferred stocks

. Corporate tax rate is 25%

a.1) Estimate the weighted average cost of capital (WACC) for this company. 30 marks

a.2) Explain why applying WACC to every project might lead managers to misleading investment decisions.

c) Read the article Best practices in estimating the cost of capital: an update by Brotherson et al (2013) and discuss the difficulties encountered by practitioners in estimating weighted average cost of capital.

Question 3: The modern theory capital structure began with the celebrated paper of Modigliani and Miller (1958). Since then, many economists have followed the path they mapped. Discuss, compare and contrast the competing theories of capital structure with reference to both theoretical and empirical literature. (100 marks)