Lightyear, Inc. has 60,000 semi-annual bonds outstanding that are selling at par ($1,000 a bond). The bonds have a coupon of 6.0%. The company has 2.5 million shares of common stock outstanding. The common stock has a beta of 1.4 and sells for $62 a share. The U.S. Treasury bill (a proxy for the risk free rate) is yielding 0.8% and the return on the market is 10.0%. The corporate tax rate is 20%. What is the firm's weighted average cost of capital? (You need to calculate the cost of debt, and equity, and the weights of each. Then you can calculate the WACC.)
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
1- Lightyear, Inc. has 60,000 semi-annual bonds outstanding that are selling at par ($1,000 a bond). The bonds have a coupon of 6.0%. The company has 2.5 million shares of common stock outstanding. The common stock has a beta of 1.4 and sells for $62 a share. The U.S. Treasury bill (a proxy for the risk free rate) is yielding 0.8% and the return on the market is 10.0%. The corporate tax rate is 20%. What is the firm's weighted average cost of capital? (You need to calculate the cost of debt, and equity, and the weights of each. Then you can calculate the WACC.)
2- Consider a company with different EBIT for different states of the world: Bad = $15,000; Average = $20,000; and Good = $25,000. The company has 1000 shares outstanding, and each share is valued at $300. The company is considering changing its capital structure to 50% debt which it can secure at 6%. What are the EPS for the company under each state of the world and under each capital structure (there are 6 total EPS)?
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