Question

Terck, a leading pharmaceutical company, currently has a balance sheet that is as follows:
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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  • CreatedApril 15, 2015
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