Terck, a leading pharmaceutical company, currently has a balance sheet that is as follows: The firms income
Question:
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The firm€™s income statement looks as follows:
Revenues.............. $1,000
Cost of goods sold (COGS) ........ $400
Depreciation ............. $100
EBIT ................ $500
Longterm interest expense ....... $100
EBT ................ $400
Taxes .............. $200
Net income ............. $200
The firm€™s bonds are all 20-year bonds with a coupon rate of 10% that are selling at 90% of face value (the yield to maturity on these bonds is 11%). The stocks are selling at a P/E ratio of 9 and have a beta of 1.25. The risk-free rate is 6%.
a. What is the firm€™s current cost of equity?
b. What is the firm€™s current after-tax cost of debt?
c. What is the firm€™s current weighted average cost of capital?
Assume that management of Terck, which is very conservative, is considering doing an equity for debt swap (i.e., issuing $200 more of equity to retire $200 of debt). This action is expected to lower the firm€™s interest rate by 1%.
d. What is the firm€™s new cost of equity?
e. What is the new WACC?
f. What will the value of the firm be after the swap?
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Step by Step Answer:
a Current Cost of Equity 6 125 55 1288 b Current Aftertax ...View the full answer
