This is the answer given in the solutions for EOC Reading 35, Q12:
B is correct.
- Capital structure: Market value of debt: FV = $10,000,000, PMT = $400,000, N = 10, I/YR = 13.65%. Solving for PV gives the answer $7,999,688 (I can’t seem to get PV equal to this)Market value of equity: 1.2 million shares outstanding at $10 = $12,000,000 Market value of debt $7,999,688 40% Market value of equity 12,000,000 60% Total capital $19,999,688 100%
To raise $7.5 million of new capital while maintaining the same capital structure, the company would issue $7.5 million × 40% = $3.0 million in bonds, which results in a before-tax rate of 16 percent.
rd(1 − t) = 0.16(1 − 0.3) = 0.112 or 11.2%
re = 0.03 + 2.2 (0.10 − 0.03) = 0.184 or 18.4%
WACC = [0.40(0.112)] + [0.6(0.184)] = 0.0448 + 0.1104 = 0.1552 or 15.52%
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Basically I input all the following into my calculator as shown above:
FV = $10,000,000, PMT = $400,000, N = 10,
I/YR = 13.65%, yet I get a PV value of 4,896,931.51 as opposed to 7,999,688.
Any help is much appreticated, thanks!