Chapter 9 WEEK 6 (sheet 2)

8/7/2019 Chapter 9 WEEK 6 (sheet 2)

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Travelers Inn Incorporated: Book Values, Market Values, and the T

Balance Sheets

Assets

Cash $10

Receivables $20

Inventories $20

Total Current Assets $50

Net fixed assets $50

Total assets $100

1. Short term debt consists of bank loans that currently cost 10% with int

so bank loans are zero in the off-season.

2. The long term debt consists of 20 year semi-annual payment mortgag

If new bond were sold, they would have a 12% yield to maturity.

3. The company's perpetual preferred stock has a $100 par value, pays

the same yield to investors and the company would incur a 5% flotati

4. The company has 4 million shares of common stock outstanding, P0

on average equity was 24% in 2008, but management expects to incr

optimism in this regard.

5. Betas as reported by security analysts, range from 1.3 to 1.7; the T-b


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brokerage house analysts report forecasted dividend growth rates in t

6. The company's vice president recently polled some pension fund man

need to be make them willing to buy the common rather than bonds,

7. The federal, plus state tax bracket is 40%.

8. The company's principal investment banker predicts a decline in inter

expected inflation rate could lead to an increase rather than a decrea

Estimate the company's WACC under the assumption that no new equ

as the assets the company now operates.

Number of years to maturity 20

Number of payments per year 2

Annual coupon rate 8%

Par value $1,000

Current price = PV = 1084.11

Current price = PV = ($1,084.11)

N = 40

PMT = $40

FV = $1,000

3.60%

7.20%

Number of years to maturity 20

Number of payments per year 2

Annual coupon rate 12%

Face value $1,000

Tax rate 40%

N = 40

PV = ($608.84)PMT = $60

FV = $1,000

10.00%

20.00%

I/YR = rd

=

Annualized rd =

I/YR = rd

=

Annualized rd

=


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12.00%A-T rd =


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Chapter 9. Problem 17

rget Capital Structure (Millions of Dollars, December 31, 2009)

Liabilities and Equity

Accounts payable $10 10%

Accruals $10 10%

Spontaneous liabilities $20 20%

Short term debt $5 $5

Total Current Liabilities $25 25%

Long-term debt $30 30% $30

Total liabilities $55 55% $35

Preferred stock $5 5% $5

Common stock $10 10% $10

Retained earnings $30 30% $30

Total common equity $40 40% $40

Total liabilities and equity $100 100% $80

erest payable quarterly. These loans are used to finance receivables and inventories on a s

e bonds with a coupon rate of 8%. Currently, these bonds provide a yield to investors of rd =

a quarterly dividend of $2, and has a yield to investors of 11%. New perpetual preferred woul

n cost to sell it.

$20, but the stock has recently traded in the price range from $17 to $23. D0 = $1 and EPS

ease this return on equity to 30%; however, security analysts and investors generally are not

nd rate is 10%, and RPm is estimated by various brokerage houses to be in the range from

Percentof Total

BookValue


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e range of 10% to 15% over the foreseeable future.

agers who hold the company's securities regarding what the minimum rate of return on the c

iven that the bonds yielded 12%. The responses suggested a risk premium over the bonds

st rates, with rd falling to 10% and the T-bond rate to 8%, although the bank acknowledges t

e in interest rates.

ity will be issued. Your cost of capital should be appropriate for use in evaluating projects th

Pref. Dividend $8.00

Par value $100.00

Flotation % 5.0%

Net preferred issue price $95.00

8.42%

0.00%

20.00%

rps

=

wd (short)

wd (long)


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Investor-Supplied Capital

ook Market

6.3% $5 4.17%

37.5% $30 25.00%

43.8% $35 29.17%

6.3% $5 4.17%

12.5%

37.5%

50.0% $80 66.67%

100.0% $120 100.00%

asonal basis

12%.

ld have to provide

= $2. ROE based

aware of management's

.5% to 5.5%. Some

TargetCapital

StructurePercentof Total

MarketValue

Percentof Total

wd

=

wps

=

ws =


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mpany's common stock would

f 4 to 6 percentage points.

hat an increase in the

t are in the same risk class

Beta 1.70

10-year T-bond yield 8.0%

Market risk premium 5.5%

17.35%

Risk-free rate 8.0%

Market risk premium 5.5%

Beta 1.7

+

8.0% + 5.5% 1.7

8.0% + 9.4%

17.35%

Growth rate of dividend 10.0%

Stock price $100.00

Expected dividend $8.00

18.00%

WACC = Weighted average cost of capital

=

Cost of debt

Cost of preferred stock

Cost of stock (comon equity)

Percent of target capital structure financed with debt

rs

=

rs

= rRF

(RPM) (b

i)

rs

=

rs =

rs

=

rs

wd

rd(1 T) + w

psr

ps+ w

sr

s

rd

=

rps

=

rs

=

wd

=


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Percent of target capital structure financed with preferred stock

Percent of target capital structure financed with stock (common e

T = Tax rate

wps

=

ws

=


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Required Answers:

wd (short)

wd (long)

wpsw

s

rd

rps

rs


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quity)


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rd = 12%(1-.40)rd = 7.20%

PROBLEM

New perpetual preferred has a yield to investors of 11%.

Annual dividend on new preferred = 11% ($100) = $11

Par value $100.00Flotation % 5.0%

Pref. Dividend Pref. Stock Price (1 - F)

$11 100(1-0.05)

11.60%

11.6%

COST OF COMMON EQUITY , r(s)

cost of common equity by CAPM approach:

Formula:

b = beta of systematic risk of the firm

RPM = Expected market risk premium

Risk Free Rate

In this Question , We have:

r(RF) = 10%= T-bond rate

RP(m) = ranges from 4.5 to 5.5 %

Beta = ranges from 1.3 to 1.7

so, we can get r(s) as

COST OF DEBT, rd

The relevant cost of debt is the after-tax cost of new debt, taking account of the tax deductibility of interest.rate (or the before-tax cost of debt) times one minus the tax rate.

The after-tax cost of debt-capital = The Yield-to-Maturity on long-term debt x (1 minus the margi

COST OF PREFERRED STOCK, rp

The cost of preferred stock is simply the preferred dividend divided by the price the company will receive inecessary, as preferred dividends are not tax deductible.

rps

=

rps

=

rps

=

rs=R

RFb RP

M

R RF =


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Highest r(s) = 10% + (5.5)(1.7) = 19.35%

Midpoint r(s) = 10% + (5.)(1.5) = 17.50%

Lowest r(s) = 10%+(4.5)(1.3) = 15.85%


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The after-tax calculated by multiplying the interest

inal tax rate in %)

it issues new preferred stock. No tax adjustment is


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Number of Peri 40 40 40

RATE 12% 6% 1%

$8.24

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Chapter 9 WEEK 6 (sheet 2)