Plastic Parts Co. is a publicly traded company. Its beta is 0.85. The market risk premium is 11.5% and T-bills are yielding 2.2%. PPC just paid a dividend of $1.15 and its stock is trading at $22. Analyst consensus is that PPC dividends should grow at 6%.

PPC has 20 million common shares outstanding.

The firm has a $15 million bank loan that is held at the bank (the loan is not trading on a secondary market) at 6.25% APR. It pays the bank interest annually.

PPC has a $100 million bond outstanding. The bond has 5 years to maturity, is trading at 110, and has a coupon of 8%. PPC pays interest on the bond semi-annually.

PPC’s tax rate is 35%.

a. If you compare PPC to another plastics/ chemical firm that has a beta of 1.1, which would be considered the “riskier” stock? Why?

b. How does PPC’s risk premium compare to the market risk premium?

c. You have a stock portfolio with a beta of 1.27. What is the expected return of your portfolio? (Hint: Use the CAMP to estimate the expected return of your portfolio)

d. You want to decrease the risk in your portfolio and decide to diversify by adding PPC to your portfolio. PPC will represent 5% of your new portfolio. What is the expected return of the new portfolio once you add PPC?

e. You are an analyst who must estimate an expected return for PPC shares over the coming year. What is a reasonable estimate given the above information (HINT: an expected return is the same as the cost of equity capital, and a reasonable estimate of the cost of equity capital is the average of the dividend model and the CAPM models).

f. What is the market capitalization of PPC common equity?

g. What is the cost of private (loan) debt?

h. What is the firm’s enterprise value?

i. Calculate the capital structure weights for:

1) What is the capital structure weight for equity capital?

2) What is the capital structure weight for bond capital?

3) What is the capital structure weight for loan capital?

4) What is PPC's WACC?

Answer rating: 100% (QA)

a The other comparable firm is riskier as it has a higher beta Beta is a measure of the systematic r... View the full answer