Question

Assignment 3

At the beginning of the year, FPT Inc. had 1 million common shares outstanding. It also had total bonds outstanding worth $5 million. Recently, the company has decided to go through a financial restructuring. The company has issued additional 2000 bonds. Each bond has a face value of $1000, and will mature in 10 years. The company decided to offer an annual coupon rate so that the bonds could be sold at its face value (the company's outstanding bonds were also selling at their face value). The coupon rate that has been offered is 10%. The coupon will be paid annually. The company used all the proceeds from selling the additional bonds to buy back common shares. They bought each share at a price of $10 each. After the restructuring is complete, at present, each common share is trading at $10, and the bonds (both previously outstanding and the new issue) are trading at their face value. Your job is to calculate the weighted average cost of capital of the company after the financial restructuring. To do that, you have also acquired additional information. The company faces a tax rate of 30%. You have decided to use the SML equation to calculate the cost of common equity. You estimate that the risk-free rate is 5%, and the market risk premium is 5% as well and the beta of of the firm is 1.7578. What is the WACC of the company at this point?

Answer 1

1]	Cost of equity per CAPM = 5.00%+1.7578*5.00% =	13.79%
3]	After tax cost of debt = 10.00%*(1-30%) =	7.00%
4]	Calculation of WACC:
	Source of capital	Market value in $ million	Weight	Component cost	WACC
	Debt [MV = $5m + $2m]	$                      7.00	46.67%	7.00%	3.27%
	Common stock [MV = $10m-$2M]	$                      8.00	53.33%	13.79%	7.35%
	Total	$                    15.00			10.62%
	WACC = 10.62%