Week 13 Solutions
Week 13 Solutions
Chapter 19
14. WACC – Table 19.4 shows a simplified balance sheet for Rensselaer Felt. Calculate this company’s weighted-average cost of capital. The debt has just been refinanced at an interest rate of 6% (short term) and 8% (long term). The expected rate of return on the company’s shares is 15%. There are 7.46 million shares outstanding, and the shares are trading at $46. The tax rate is 35%.
We make three adjustments to the balance sheet:
Ignore deferred taxes; this is an accounting entry and represents neither a liability nor a source of funds.
“Net out” accounts payable against current assets.
Use the market value of equity (7.46 million x $46).
Now the right-hand side of the balance sheet (in thousands) is:
Short-term debt $75,600
Long-term debt 208,600
Shareholders’ equity 343,160
Total $627,360
The after-tax weighted-average cost of capital formula, with one element for each source of funding, is:
WACC = [rD – ST (1 – Tc) (D-ST/V)] + [rD – LT (1 – Tc) (D − LT/V)] + [rE (E/V)]
WACC = [0.06 (1 – 0.35) (75,600/627,360)] + [0.08 (1 – 0.35) (208,600/627,360)] + [0.15 (343,160/627,360)]
= 0.004700 + 0.017290 + 0.082049 = 0.1040 = 10.40%
15. WACC – How will Rensselaer Felt’s WACC and cost of equity change if it issues $50 million in new equity and uses the proceeds to retire long-term debt? Assume the company’s borrowing rates are unchanged. Use the three-step procedure from Section 19-3.
Assume that short-term debt is temporary. From Problem 14:
Long-term debt $208,600
Shareholder equity 343,160
Total $551,760
Therefore: D/V = $208,600/$551,760 = 0.378
E/V = $343,160/$551,760 = 0.622
Step 1: r = rD (D/V) + rE (E/V) = (0.08 0.378) + (0.15 0.622) = 0.1235
Step 2: rE = r + (r – rD) (D/E) = 0.1235 + (0.1235 – 0.08) 0.403 = 0.1410
Step 3:
WACC = [rD (1 – TC) (D/V)] + [rE (E/V)] = (0.08 0.65 0.287) + (0.1410 0.713) = 0.1155 = 11.55%
17. APV – Consider another perpetual project like the
Chapter 19
14. WACC – Table 19.4 shows a simplified balance sheet for Rensselaer Felt. Calculate this company’s weighted-average cost of capital. The debt has just been refinanced at an interest rate of 6% (short term) and 8% (long term). The expected rate of return on the company’s shares is 15%. There are 7.46 million shares outstanding, and the shares are trading at $46. The tax rate is 35%.
We make three adjustments to the balance sheet:
Ignore deferred taxes; this is an accounting entry and represents neither a liability nor a source of funds.
“Net out” accounts payable against current assets.
Use the market value of equity (7.46 million x $46).
Now the right-hand side of the balance sheet (in thousands) is:
Short-term debt $75,600
Long-term debt 208,600
Shareholders’ equity 343,160
Total $627,360
The after-tax weighted-average cost of capital formula, with one element for each source of funding, is:
WACC = [rD – ST (1 – Tc) (D-ST/V)] + [rD – LT (1 – Tc) (D − LT/V)] + [rE (E/V)]
WACC = [0.06 (1 – 0.35) (75,600/627,360)] + [0.08 (1 – 0.35) (208,600/627,360)] + [0.15 (343,160/627,360)]
= 0.004700 + 0.017290 + 0.082049 = 0.1040 = 10.40%
15. WACC – How will Rensselaer Felt’s WACC and cost of equity change if it issues $50 million in new equity and uses the proceeds to retire long-term debt? Assume the company’s borrowing rates are unchanged. Use the three-step procedure from Section 19-3.
Assume that short-term debt is temporary. From Problem 14:
Long-term debt $208,600
Shareholder equity 343,160
Total $551,760
Therefore: D/V = $208,600/$551,760 = 0.378
E/V = $343,160/$551,760 = 0.622
Step 1: r = rD (D/V) + rE (E/V) = (0.08 0.378) + (0.15 0.622) = 0.1235
Step 2: rE = r + (r – rD) (D/E) = 0.1235 + (0.1235 – 0.08) 0.403 = 0.1410
Step 3:
WACC = [rD (1 – TC) (D/V)] + [rE (E/V)] = (0.08 0.65 0.287) + (0.1410 0.713) = 0.1155 = 11.55%
17. APV – Consider another perpetual project like the