Fundermantals of Cooperate Finance

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Fundermantals of Cooperate Finance

By | May 2013
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Lab 8 question 3 chapter 13

Question 3 [8 points]
Your solution to the question was:

Southgate Inc.'s stock sells for a price of $27. The total book value of the firm's equity is $1,000,000, book value per share is $20. The cost of equity is 20 percent. The firm's bonds have a par value of $600,000 and sell at a price of 119 percent of par. The yield to maturity on bonds is 11 percent, and the firm's tax rate is 34 percent.

a) What is the market value of Southgate Inc.'s debt (D)?

Market Value of Debt = $

Marking:
Your answer was:
The correct answer was: $714,000.00

As the firm's bonds have a par value of $600,000, and they are selling at a price of 119 percent of par, the market value of the debt is therefore:

Market Value of Debt = D = $600,000 par value × 1.19 = $714,000

You will lose 2 marks for this part.

b) What is the market value of Southgate Inc.'s equity (E)?

Market Value of Equity = $

Marking:
Your answer was:
The correct answer was: $1,350,000.00

To find the Market Value of Equity, we can take the share price × the number of shares. To find the number of shares we can take the total book value of equity ÷ book value per share. Therefore: Number of Shares = | $1,000,000 book value|

|
$20 book value/share|
| = 50,000 shares|

Market Value of Equity = E = $27 per share × 50,000 shares = $1,350,000

You will lose 2 marks for this part.

c) What is the WACC of Southgate Inc.? (Enter your value in percentage form to 2 decimal places)

WACC = %

Marking:
Your answer was:
The correct answer was: 15.59%
WACC = | D|
|
V|
| [(1 - Tc) × rdebt] + | E|
|
V|
| × requity|
|

D = Market Value of Debt = $714,000, E = Market Value of Equity = $1,350,000, V = E + D = $2,064,000 Tc = corporate tax rate = 34 percent, rdebt = required rate of return on debt = 11 percent, requity = required rate of return on equity = 20 percent

Therefore...
WACC = | $714,000|...

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