Answer:
1) For cost of Mortgage Bonds(post tax): =
For cost of Unsecured Bonds(post tax) : =
For cost of Stock (using CAPM Model)
= Risk free Rate + Risk Premium
= 0.03 +0.08 = 0.110
2) Weighted Average Cost of Capital =
= 0.0809
3. Economic Value Added
Operating Income after Tax = $1,197,000
Less : Cost of Capital= [(2,000,000 + 4,000,000 + 9,000,000) * 0.0809] = $1,213,500
Economic Value Added =
($1,197,000 - $1,213,500) = $ 405,500
4. If Risk premium is 5%:
Revised Cost of Stock = (0.03 + 0.05 ) 0.08
Therefore, Revised WACC =
= 0.0629
If gnacio, Inc., had common stock which was less risky than other stocks and commanded a risk premium of 5%, the WACC would be lower.
Revised EVA will be:
Operating Profit After Tax = $ 1,197,000
Cost of Capital :
[(2,000,000 + 4,000,000 + 9,000,000) * 0.0629] = $934,500
Economic Value Added = $262,500.
