1. The total book value of WTC�s equity is $30 million and book value per share outstanding is $10. The stock of WTC is currently selling for a price of $35 per share and the beta of WTC is .95. The bonds of WTC have a face value of $42 million and sell at a price of 104 percent of face value. The yield to maturity on the bonds is 6.5 percent and the firm�s tax rate is 35 percent. If the E(Rm) = 8% and Rf = 1%, calculate the WACC of WTC.
2. Suppose the company in #1 is considering the following expansion projects. How would you calculate the required rate of return to use in the NPV analysis of the following: Explain.
(a) The company is considering an expansion to double the production of its current product. The company will issue either equity or debt (but not both) to pay for the expansion.
(b) The company is considering adding a new product in a different line of business that is unrelated to their current product.
1
Calculation of WACC of WTC
Stock Book Value = $30,000,000
Now No. of sahre =$30,000,000/10$per share = 3,000,000 sharesStock
Market Value = 3,000,000 shares x 35$per share =
$105,000,000
Bonds Book Value = $42,000,000
Bonds Market Value = $42,000,000 x 1.04 =
$43,680,000
WACC = [d/v x (1 – TC) rdebt]+[e/v x requity]
rdebt= YTM = 6.5% =
.065
requity
= CAPM = rf+B (rm– rf)
= .01 + .95(.08 – .01)
=
.0765
v =
$105,000,000+ $43,680,000
= $148,680,000
WACC
= [43,680,000/148,680,000x (1 – .35).065]+[ 105,000,000/148,680,000 x.0965] =0.066511
=
6.65%
Answrer:2
(1)
This project should have same risk as company’s current operations.For required rate of return, best choice is to use CAPM and beta of assets for the project.
In this particular case, WACC will work like required rate of return if company issues debt & equity in same proportions like current capital structure to pay for new project.
If company issues all the debt or all equity, theen WACC will not be appropriatediscount rate
(2)
The company should find the assets of new line of business a, & use CAPM for finding discount rate.
WACC will not be appropriate here unless by the coincidence there of new product line is exactly same as current product, new product it financed using same mix of debt & equity & risk-free rate & market risk premium are the same.
