Question
Terck Inc., a leading pharmaceutical company, currently has a balance sheet that is as follows: Liability Assets LT Bonds $1000 Fixed Assets 1700 Equity $1000
Terck Inc., a leading pharmaceutical company, currently has a balance sheet that is as follows:
Liability
Assets
LT Bonds
$1000
Fixed Assets
1700
Equity
$1000
Current Assets
300
Total
$1000
Total
1000
The firm's income statement looks as follows:
Revenues
1000
COGS
400
Depreciation
100
EBIT
500
LT Interest
100
EBT
400
Taxes
200
Net Income
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?
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 will the value of the firm be after the swap?
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Financial Management Core Concepts
Authors: Raymond M Brooks
3rd edition
133866696, 978-0133866698
