Question 3 Company Background: GAP Ltd. is considering a new project that requires a large initial cost, and it needs to calculate its weighted average cost of capital (WACC) to decide whether to proceed with the project. Capital Structure: - Common Stock: 2.5 million shares outstanding, with a par value of $1 per share, and a market price of $5.5 per share. - Preferred Stock: 500,000 shares outstanding, with a par value of $10 per share, and a current market price of $13 per share. The preferred stock pays an annual dividend of $0.75 per share. - Debt: 30,000 zero coupon bonds outstanding with face value of $1,000 each. The issue price of the bonds is $850 per bond. The bonds have 4-year maturity and currently trade in the market at $900 per bond. The bonds compound semi-annually. Market Information: - The current risk-free rate is 3%. - The expected market return is 8.5%. - The company's beta is 0.8 . - The company is in the 35% corporate tax bracket. (a) Compute the cost of equity (RE) using CAPM, cost of preferred stock ( RP), and pre-tax cost of debt (RD). [Answers in \%] (9 marks) (b) Assuming that the company is going to maintain the current capital structure, based on your answer in part (a), calculate the weighted average cost of capital (WACC) of the company. [Answer in \%] (9 marks) -- End of Assignment 2 -- Question 3 Company Background: GAP Ltd. is considering a new project that requires a large initial cost, and it needs to calculate its weighted average cost of capital (WACC) to decide whether to proceed with the project. Capital Structure: - Common Stock: 2.5 million shares outstanding, with a par value of $1 per share, and a market price of $5.5 per share. - Preferred Stock: 500,000 shares outstanding, with a par value of $10 per share, and a current market price of $13 per share. The preferred stock pays an annual dividend of $0.75 per share. - Debt: 30,000 zero coupon bonds outstanding with face value of $1,000 each. The issue price of the bonds is $850 per bond. The bonds have 4-year maturity and currently trade in the market at $900 per bond. The bonds compound semi-annually. Market Information: - The current risk-free rate is 3%. - The expected market return is 8.5%. - The company's beta is 0.8 . - The company is in the 35% corporate tax bracket. (a) Compute the cost of equity (RE) using CAPM, cost of preferred stock ( RP), and pre-tax cost of debt (RD). [Answers in \%] (9 marks) (b) Assuming that the company is going to maintain the current capital structure, based on your answer in part (a), calculate the weighted average cost of capital (WACC) of the company. [Answer in \%] (9 marks) -- End of Assignment 2
