ABBC Inc operates a very successful chain of yogurt and
ABBC Inc. operates a very successful chain of yogurt and coffee shops spread across the southwestern part of the United States and needs to raise funds for its planned expansion into the Northwest. The firm’s balance sheet at the close of 2009 appeared as follows:
At present the firm’s common stock is selling for a price equal to 2.5 times its book value, the firm’s investors require an 18 percent return, the firm’s bonds command a yield to maturity of 8 percent, and the firm faces a tax rate of 35 percent. At the end of the previous year ABBC’s common stock was selling for a price of 2.5 times its book value, and its bonds were trading near their par value.
a. What does ABBC’s capital structure look like?
b. What is ABBC’s weighted average cost of capital?
c. If ABBC’s stock price were to rise such that it sold at 3.5 times its book value and the cost of equity fell to 15 percent, what would the firm’s weighted average cost of capital be (assuming the cost of debt and tax rate do not change)?
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