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Ramblin Wreck is a firm specializing in engineering components. The firm is publicly traded and is...

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Finance

Ramblin Wreck is a firm specializing in engineering components.The firm is publicly traded and is considering the followingproject:

The project will last 5.00 years with an annual cash flow of$40.00 million. The project will require an initial investment of$140.00 million

The firm must determine the cost of capital to evaluate theproject. (The project is within the firm’s normal activities)

Ramblin Wreck, Inc. Financial Data:

STOCK DATA:BOND DATA:
Current Price Per Share$29.00Current Price Per Bond$936.00
# of Shares2.00 million# of bonds20,000.00
Book Value$50 millionAnnual Coupon Rate8.00%
Face Value Per Bond$1,000
Maturity10 years


The risk free rate in the economy is currently 2.00%, whileinvestors have a market risk premium of 8.00%. Ramblin Wreck, Inc.has a beta of 1.42. The tax rate is 36.00%.

a) What is the yield to maturity on Ramblin Wreck, Inc.bonds?

b) What is the cost of equity?

c) What is the weight in debt for the project?

Answer & Explanation Solved by verified expert
4.4 Ratings (734 Votes)

a

                  K = N
Bond Price =? [(Annual Coupon)/(1 + YTM)^k]     +   Par value/(1 + YTM)^N
                   k=1
                  K =10
936 =? [(8*1000/100)/(1 + YTM/100)^k]     +   1000/(1 + YTM/100)^10
                   k=1
YTM% = 9

b

As per CAPM
expected return = risk-free rate + beta * (Market risk premium)
Expected return% = 2 + 1.42 * (8)
Expected return% = 13.36

c

Total Firm value = price of Debt*Shares of Debt + price of Equity*Shares of Equity
=936*20000+29*2000000
=76720000
Weight of Debt = price of Debt*Shares of Debt/Total Firm Value
= 18720000/76720000
=0.244

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Transcribed Image Text

Ramblin Wreck is a firm specializing in engineering components.The firm is publicly traded and is considering the followingproject:The project will last 5.00 years with an annual cash flow of$40.00 million. The project will require an initial investment of$140.00 millionThe firm must determine the cost of capital to evaluate theproject. (The project is within the firm’s normal activities)Ramblin Wreck, Inc. Financial Data:STOCK DATA:BOND DATA:Current Price Per Share$29.00Current Price Per Bond$936.00# of Shares2.00 million# of bonds20,000.00Book Value$50 millionAnnual Coupon Rate8.00%Face Value Per Bond$1,000Maturity10 yearsThe risk free rate in the economy is currently 2.00%, whileinvestors have a market risk premium of 8.00%. Ramblin Wreck, Inc.has a beta of 1.42. The tax rate is 36.00%.a) What is the yield to maturity on Ramblin Wreck, Inc.bonds?b) What is the cost of equity?c) What is the weight in debt for the project?

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