Case:-
Assuming that ABC Firm has an optimal capital structure; comprised of debt, preferred stock and common equity. In this scenario, Firm currently has 45 percent debt, 2 percent preferred stock and 53 percent common equity in its capital structure. Firm’s before-tax cost of debt is 10 percent and corporate tax rate is 40 percent; beta for common stock is 0.85 with market return 14% and T-bills return 10%; whereas cost of preferred stock is 10.3 percent.
Required:
1. Keeping in view the above mentioned information what would be the values of the firm’s:
§ After tax cost of debt ‘Kd(1 – T)’
§ Weighted average cost of capital ‘WACC’
Note: Detailed working is not required.
2. You need to stimulate your thought and discuss the impact (increase/ decrease) on firm’s cost of equity ‘Ks’ and weighted average cost of capital ‘WACC’ if volatility of ABC Firm’s stock is increased up to 1.8. Give logical justification of your answer.
Note: Your discussion should not exceed 50 words.
Read more: MGT201 GDB Solution & Discussion Fall 2011 - Virtual University of Pakistan http://vustudents.ning.com/group/mgt201financialmanagement/forum/topics/mgt201-gdb-solution-discussion-fall-2011#ixzz1k4jlMAZF
fter Tax cost of Debt = .10 (1-.40) = 6%
WACC = 0.45(0.10)(.6) + 0.02(0.103) + 0.53(0.134) = 10.008
Cost of equity and WACC both will increase because of increase in volatility of share price in market.
Read more: MGT201 GDB Solution & Discussion Fall 2011 - Virtual University of Pakistan http://vustudents.ning.com/group/mgt201financialmanagement/forum/topics/mgt201-gdb-solution-discussion-fall-2011#ixzz1k4k2e2nH
WACC = 0.45(0.10)(.6) + 0.02(0.103) + 0.53(0.134) = 10.008
Cost of equity and WACC both will increase because of increase in volatility of share price in market.
Read more: MGT201 GDB Solution & Discussion Fall 2011 - Virtual University of Pakistan http://vustudents.ning.com/group/mgt201financialmanagement/forum/topics/mgt201-gdb-solution-discussion-fall-2011#ixzz1k4k2e2nH
