Essay About  Failure And  Coupons

Accounting Case
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Value of a firm without debt = 1.2 million / 11%
Cash flow
1,200,000
Value of a firm without debt =
10,909,091
Cost of Equity
Cost of Debt
Tax Rate
Equity
8,909,091
2,000,000
WACC = 81.67% * 11% + (7%*0.65)* 18.33%
WACC =
9.82%
After tax cash flow
1,109,000
Value of a firm with debt =
11,296,155
If the interest expense is not tax deductible the
value of the firm is same as calculated in part a.
After tax cash flow
1,060,000
New WACC
10.27%
Value of a firm with debt =
10,324,675
Cost of equity capital
Different Contractual Obligations
Debt:
 An obligation to make periodic, fixed
payments to lenders
 Failure to make timely payments: default
 Default is followed by transfer of control
(ownership) to lenders
Different Contractual Obligations
Equity:
 No obligation to make fixed payments
 Claim on residual cash flows
 Residual cash flow:
 Whats left after everyone has been paid
 All claims on the firms assets have been met
(including future investment needs)
Cost of Debt
 Estimate YTM using most recent bond price
 Example: 5-year 10% coupon bond sells for
$1,100
 Coupons paid semiannually
 YTM = 7.56% (APR)
 EAR = (1+0.0756/2)2 – 1 = 0.0770 = 7.7%
 RD = 7.7%
 Is this the true cost of debt? Taxes?
Raise