Ques 2

Ques 3
The pre-tax cost is computed as shown below:
weighted average cost of capital = pretax cost of debt (1 - tax rate) x weight of debt + cost of equity x
weight of equity
0.135 = pretax cost of debt (1 - 0.35) x 0.45 / 1.45 + 0.176 x 1 / 1.45

0.135 = pretax cost of debt x 0.201724138 + 0.12137931

(0.135 - 0.12137931) / 0.201724138 = pretax cost of debt

6.75% Approximately = Pretax cost of debt

Ques 4
Debt:

Face Value of Debt = $450,000

Market Value of Debt = 102% * $450,000

Market Value of Debt = $459,000

Pre-tax Cost of Debt = 8.49%

After-tax Cost of Debt = 8.49% * (1 - 0.30)

After-tax Cost of Debt = 5.943%

Preferred Stock:

Number of shares outstanding = 5,000

Current Price = $58

Annual Dividend = 7.00% * $100

Annual Dividend = $7

Market Value of Preferred Stock = 5,000 * $58

Market Value of Preferred Stock = $290,000

Cost of Preferred Stock = Annual Dividend / Current Price

Cost of Preferred Stock = $7 / $58
Cost of Preferred Stock = 12.069%
Common Stock:

Number of shares outstanding = 35,000

Current Price = $47

Market Value of Common Stock = 35,000 * $47

Market Value of Common Stock = $1,645,000

Cost of Common Stock = 13.50%

Answer a.

Market Value of Firm = Market Value of Debt + Market Value of Preferred Stock + Market Value of
Common Stock
Market Value of Firm = $459,000 + $290,000 + $1,645,000
Market Value of Firm = $2,394,000

Answer b.

Weight of Debt = $459,000 / $2,394,000

Weight of Debt = 0.192

Weight of Preferred Stock = $290,000 / $2,394,000

Weight of Preferred Stock = 0.121

Weight of Common Stock = $1,645,000 / $2,394,000

Weight of Common Stock = 0.687

Answer c.

WACC = Weight of Debt * After-tax Cost of Debt + Weight of Preferred Stock * Cost of Preferred
Stock + Weight of Common Stock * Cost of Common Stock
WACC = 0.192 * 5.943% + 0.121 * 12.069% + 0.687 * 13.500%
WACC = 11.88%

Ques 5
Note:
A) Under the residual dividend payout policy, the company will pay off all the residual earnings as
dividends after covering the capital expenditures. Thus, in the given question, assumed the company will
maintain the same debt-equity ratio, and hence 65% of the investment will be financed by equity which
is reduced from the net income and residual is given as dividend.
B) Ex-dividend price = Share Price before dividend - (Dividend per share * (1-tax rate))
C) The current value of a firm's equity equals the present value of all future dividends. Since the
company is providing liquidating dividend in year 1, it implies there will be no future dividends.