Terck, a leading pharmaceutical company, currently has a balance sheet that is as follows:
Liabilities Assets
Long-term Liab $ 1,000 Fixed Assets $ 1,700
Equity $ 1,000 Currents Assets $ 300
Total $ 1,000 Total $ 1,000
The firm's income statement looks as follows:
Income Statement
Revenues $ 1,000
COGS $ 400
Depreciation $ 100
EBIT $ 500
Long-term Int. Exp $ 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? (zero growth rate)