# Week 2

Topics: Weighted average cost of capital, Finance, Modigliani-Miller theorem Pages: 2 (420 words) Published: August 9, 2012
Week 2 Assignment
Chapter 15
Bickley Engineering Company has a capital structure of 30% Debt and 70% Equity. Its current Beta is 1.3, and its Market Risk Premium is 7.5% Points. The current Risk Free Rate is 3.5%. Bickley’s marginal tax rate is 40%. What is the Unlevered Beta of Bickley?

Unlevered beta = levered beta/(1+(1-T) D/E)
= 1.3 /(1+(1-0.4)X(0.3/0.7) = 1.03
Bickley’s management would like to change its capital structure to 15% Debt and 85% equity by retiring its bonds yielding 8%. The remaining long term debt will be at 7%. The marginal tax rate will remain the same. What will be Bickley’s new Beta with this new 15/85 capital structure? New beta = 1.03 X (1+ (1-0.4) X 0.15/0.85 = 1.14

What is the WACC (Weighted Average Cost of Capital) of Bickely with its 30/70 capital structure? Bickley’s average borrowing rate with this capital structure is 7.5%. WACC = Proportion of debt X after tax cost of debt + Proportion of equity X cost of equity Using CAPM

Cost of equity = Rf + (Rm-Rf) beta = 3.5% + 7.5% X 1.3 = 13.25% WACC = 0.3 X 7.5% X (1-0.4) + 0.7 X 13.25% = 10.625%
What will be Bickley’s WACC with its 15/85 capital structure? Cost of equity = 3.5% + 7.5% X 1.14 = 12.05%
WACC = 0.15 X 7% X (1-0.4) + 0.85 X 12.05% = 10.87%

Chapter 26
Yancey Industries' Free Cash Flow for the past 12 months is \$2.0 Million, and the future expected growth rate of this FCF is 6.5%. Yancey has no debt in its current capital structure. Its Cost of Equity is 11.5%. Its tax rate is 35%.

Calculate the Unlevered Value of Yancey (Vu).
Unlevered value = FCF 1/(Cost of equity - growth rate)
FCF 1 = FCF 0 X (1+g) = 2.0 X 1.065
Unlevered value = 2.0 X 1.065/(11.5% - 6.5%) = \$42.6 million

Calculate VL and rsL for the scenario whereby Yancey uses \$8.0 Million Debt costing 8%. VL = Vu + (rdTD/rsU - g)
= 42.6 + (8% X 35%X8/(11.5%-6.5%)
= \$47.08 million
rsL = rsU + (rsU - rd) D/S
Value of debt D = 8 million
Value of equity S = 47.08 -8 = 39.08
rsL = 11.5% +...