Question
Assignment 6
Question 1 10 points
1 Calculating Cost of Equity: The Dybvig Corporation’s common
stock has a beta of 1.21. If the risk- free rate is 3.5 percent and
the expected return on the market is 11 percent, what is Dybvig’s
cost of equity capital?
Question 2 -10 points
Calculating Cost of Debt: Shanken Corp. issued a 30-year, 6.2
percent semi-annual bond 7 years ago. The bond currently sells for
108 percent of its face value. The company’s tax rate is 35 percent
(a.) What is the pretax cost of debt?
(b). What is the aftertax cost of debt?
(c) Which is more relevant, the pre-tax or the after-tax cost
of debt? Why?
Question 3 – 15 points
Calculating WACC Mullineaux Corporation has a target capital
structure of 70 percent common stock and 30 percent debt. Its cost
of equity is 13 percent, and the cost of debt is 6 percent. The
relevant tax rate is 35 percent. What is Mullineaux’s WACC?
Question 4 – 65 points
Kellogg’s wants to expand its cereal business by acquiring
Major foods company. Kellogg’s currently has debt outstanding with
a market value of $150 million and a YTM of 7 percent. The
company’s market capitalization is $390 million, and the required
return on equity is 12 percent. Major foods has debt outstanding
with a market value of $32 million. The EBIT for Major Foods is
projected to be $14 million. EBIT is expected to grow at 11 percent
per year for the next five years before slowing to 2 % in
perpetuity. Net working capital, capital spending, and depreciation
as a percentage of EBIT are expected to be 10 percent, 15 percent,
and 9 percent, respectively. Major Foods has 2 million shares
outstanding, and the tax rate for both companies is 40 percent.
(a). What is the maximum share price do you think
Kellogg’s should to pay for Major foods stock.
(b.) Would you recommend that Kellogg’s purchase Major foods?
Why?
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