MGT201 GDB # 2 (2012) Solution

Monday, January 16, 2012

MGT201 GDB # 2 (2012) Solution

Case:-

Assuming that ABC Firm has an optimal capital structure; comprised of debt, preferred stock and common equity. In this scenario, Firm currently has 45 percent debt, 2 percent preferred stock and 53 percent common equity in its capital structure. Firm’s before-tax cost of debt is 10 percent and corporate tax rate is 40 percent; beta for common stock is 0.85 with market return 14% and T-bills return 10%; whereas cost of preferred stock is 10.3 percent.

Required:

1. Keeping in view the above mentioned information what would be the values of the firm’s:

§ After tax cost of debt ‘Kd(1 - T)’

§ Weighted average cost of capital ‘WACC’

Note: Detailed working is not required.

2. You need to stimulate your thought and discuss the impact (increase/ decrease) on firm’s cost of equity ‘Ks’ and weighted average cost of capital ‘WACC’ if volatility of ABC Firm’s stock is increased up to 1.8. Give logical justification of your answer.

Note: Your discussion should not exceed 50 words.

Solution

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