FUNDAMENTALS OF FINANCE

Fundamentals of Finance

Fundamentals of Finance

1. WACC

(a)The total book value of Bluebell's equity is £10 million; book value per share is £20. The stock sells for a price of £30 per share, and the cost of equity is 15%. The firm's bonds have a face value of £5 million and sell at a price of 110% of face value. The yield to maturity on the bonds is 9% and the firm's tax rate is 40%. Calculate the weighted average cost of capital (WACC) of Bluebell.

Weighted Average Cost of Capital (WACC)

The Weighted Average Cost of Capital (WACC) equation is the cost of each capital component multiplied by its proportional weight and then adding it, as shown below:

Where: Re = Cost of equity Rd = Cost of debt E = Market value of the firm's equity D = Market value of the firm's debt V = E + D E/V = Percentage of financing that is equity D/V = Percentage of financing that is debt Tc = Tax rate

Solution

WACC = (0.73) (0.15) + (0.27) (0.09) (1 - 0.40)

WACC = 0.1095 + (0.0243) (0.60)

WACC = 0.1095 + 0.01458

WACC = 0.12408

WACC = 12.40%

Other Computations

No. of shares = Total equity = 10,000,000 = 500,000

Book vale per share 20

E = No. of shares x Market value

E = 500,000 x 30 = 15,000,000

D = Bond face value x Market rate

D = 5,000,000 x 110% = 5,500,000

V = E + D = 15,000,000 + 5,500,000 = 20,500,000

E/V = 15,000,000 = 0.73

20,500,000

D/V = 5,500,000 = 0.27 20,500,000

Re = 15% = 0.15

Rd = 9% = 0.09Tc = 40% = 0.40

(b) Explain the characteristics of common stocks, preferred stocks and bonds. Evaluate the risks and potential returns involved in holding these securities?

With the intention of proficiently invest your money into stocks of any type, you must recognize all of your stock choices so that you can efficiently and effectively get profit from money. Because stocks are little shares of an organization, the more stocks you will buy the more you will own an organization. There are two foremost categories of stock; the investor should become informed with, so as to correctly buy the stock that is right for you and your monetary position (Modigliani and Miller, 1958).

Common Stock

A common stock is a common share or a part of the investment. If you discover persons talking about stocks in general, it is this type of stocks they are referring. It is only a part of paper that comprises some degree of ownership of an organization as well as some pattern of earnings from that specific organization. Investors in common stocks obtain one ballot per stock belongs to vote into organization's board members, the persons who directs foremost decisions made for the business as a whole, for a certain organization. In long-term, this type of stock means capital growth for the shareholder, although, if the organization went into bankruptcy, the shareholder will not get paid what they were obliged until creditors, preferred stockholders and bondholders obtain their payments (Sharpe, ...