Weighted Average Cost of Capital] Kareem Construction Company has the following amounts of interest-bearing debt and common equity capital:
262 Part 3: Planning for the Future
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FINANCING
SOURCE
DOLLAR
AMOUNT
INTEREST
RATE
COST OF
CAPITAL
Short-term loan $200,000 12%
Long-term loan $200,000 14%
Equity capital $600,000 22%
Kareem Construction is in the 30 percent average tax bracket.
A. Calculate the after-tax WACC for Kareem.
B. Show how Kareem’s WACC would change if the tax rate dropped to 25 percent
and the estimated cost of equity capital were based on a risk-free rate of 7 percent, a market risk premium of 8 percent, and a systematic risk measure or beta
of 2.0.
Weighted Average Cost of Capital
Gardner, Inc., plans to finance its expansion by raising the needed investment capital from the following sources in the indicated proportions and respective capital cost rates:
| Capital Cost | ||
|---|---|---|
| Source | Proportion | Rate |
| Bonds | 40% | 12% |
| Preferred stock | 20% | 8% |
| Common stock | 30% | 11% |
| Retained earnings | 10% | 8% |
| 100% |
Calculate the weighted average cost of capital.
Round answers to one decimal place. For example, 0.457 = 45.7%.
| Weighted Average | |
|---|---|
| Cost of Capital | |
| Bonds | Answer
|
| Preferred stock | Answer
|
| Common stock | Answer
|
| Retained earnings | Answer
|
| Answer
|
Mullineaux Corporation has a target capital structure of 60% common stock, 5% preferred stock, and 35% debt. Its cost of equity is 14%, the cost of preferred stock is 6%, and the cost of debt is 8%. The relevant tax rate is 35%.
A. What is Mullineaux’s WACC?
B. The company president has approached you about Mullineaux’s capital structure. He wants to know why the company doesn’t use more preferred stock financing because it costs less than debt. What would you tell the president?
A company’s balance sheets show a total of $30 million long-term debt with a coupon rate of 9 percent. The yield to maturity on this debt is 11.11 percent, and the debt has a total current market value of $25 million. The balance sheets also show that that the company has 10 million shares of stock; the total of common stock and retained earnings is $30 million. The current stock price is $7.5 per share. The current return required by stockholders, rS, is 12 percent. The company has a target capital structure of 40 percent debt and 60 percent equity. The tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?
You are employed by CGT, a Fortune 500 firm that is a major producer of chemicals and plastic goods: plastic grocery bags, styrofoam cups, and fertilizers. You are on the corporate staff as an assistant to the Vice-President of Finance. This is a position with high visibility and the opportunity for rapid advancement, providing you make the right decisions. Your boss has asked you to estimate the weighted average cost of capital for the company. Following are balance sheets and some information about CGT.
Assets
Current assets $ 38,000,000
Net plant, property, and equipment $101,000,000
Total Assets $139,000,000
Liabilities and Equity
Accounts payable $ 10,000,000
Accruals $ 9,000,000
Current liabilities $ 19,000,000
Long term debt (40,000 bonds, $1,000 face value) $ 40,000,000
Total liabilities $ 59,000,000
Common Stock 10,000,000 shares) $ 30,000,000
Retained Earnings $ 50,000,000
Total shareholders equity $ 80,000,000
Total liabilities and shareholders equity $139,000,000
You check The Wall Street Journal and see that CGT stock is currently selling for $7.50 per share and that CGT bonds are selling for $889.50 per bond. These bonds have a 7.25 percent annual coupon rate, with semi-annual payments. The bonds mature in twenty years. The beta for your company is approximately equal to 1.1. The yield on a 6-month Treasury bill is 3.5 percent and the yield on a 20-year Treasury bond is 5.5 percent. The expected return on the stock market is 11.5 percent, but the stock market has had an average annual return of 14.5 percent during the past five years. CGT is in the 40 percent tax bracket.
7. Using the CAPM approach, what is the best estimate of the cost of equity for CGT?
8. What is best estimate for the after-tax cost of debt for CGT?
9. Which of the following is the best estimate for the weights to be used when calculating the WACCC?
10. What is the best estimate of the WACC for CGT?
Discuss the Weighted Average Cost of Capital (WACC) and the factors that affect it.
Why is the emphasis on cash flow instead of net income in capital budgeting?
How does capital budgeting relate to WACC?
Finally, discuss risk analysis in capital budgeting and how you should address it in making a decision (as a manager).
Dobson Dairies has a capital structure which consists of 60 percent long-term debt and 40 percent common stock. The company s CFO has obtained the following information:
· The before-tax yield to maturity on the company s bonds is 8 percent.
· The company s common stock is expected to pay a $3.00 dividend at year end (D1 = $3.00), and the dividend is expected to grow at a constant rate of 7 percent a year. The common stock currently sells for $60 a share.
· Assume the firm will be able to use retained earnings to fund the equity portion of its capital budget.
· The company s tax rate is 40 percent.
What is the company s weighted average cost of capital (WACC)?
A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm’s weighted average cost of capital.
cost of debt before tax = 6%; Tax rate = 40%; P0 = $25; Growth = 0%;
D0 = $2.00
A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions:
Target market
Source of capital proportions After tax cost
______________________________________________________
Long term debt 40% 6%
Preferred stock 10 11
Common stock equity 50 15
The weighted average cost of capital is
Please give all calculations and show the work so I can learn how it’s done.
The ABC Co is in the process of determining a return rate to use or its cost of capital. Upon review of the financial statements it was determined that the total interest bearing debt is $1,400,000 and total stockholders’ equity is $1,000,000. In addition, it was determined that the cost of debt financing is 8%, and thre cost of equity financing is
18%.
a. What proportion of the ABC co’s total financing comes from debt? (Show calculations please)
b. What proportion of the ABC co’s total financing comes from equity?
c.Calculate the ABC’s weighted average cost of captial rate.
Please show all calculations. Thanks
Calculate Weighted Average Cost of Capital (WACC) for Alcoa, Inc. Please show all work.
Here is the end of year reports for 2009
http://www.alcoa.com/global/en/investment/pdfs/2009_Annual_Report.pdf
In what situations should the WACC and the APV be used? How do personal taxes affect the use of these two methods?
Global Technology’s capital structure is as follows:
Debt = 40%
Preferred stock =15%
Common equity = 45%
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology’s weighted average cost of capital in a manner similar to Table 11-1 on page 313.
You were hired as a consultant to Quigley Company, whose target capital structure is 40% debt, 10% preferred, and 50% common equity. The interest rate on new debt is 6.50%, the yield on the preferred is 6.00%, the cost of retained earnings is 12.25%, and the tax rate is 40%. The firm will not be issuing any new stock. What is Quigley’s WACC?
These 2 questions need the attached Table 11-1.
Global Technology’s capital structure is as follows :
_______________________
Debt————————35%
Preffered stock————15
Common Equity———–50
_______________________
The aftertax cost of debt is 6.5%; the cost of preferred stock is 10%; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology’s weighted average cost of capital in a manner smiliar to table 11-1
As an alternative to the capital structure shown above for GlobalTechnology, an outside consultant has suggested the following modifications.
______________________
Debt———————-60%
Preferred stock———–5
Common equity———35
_______________________
Under this new and more debt-oriented arrangement, the after tax cost of debt is 8.8%, the cost of preferred stock is 11%, and the cost of common equity(in terms of retained earnings)is 15.6%.
Calculate Global’s weighted average cost of capital in each case in a manner smilar to table 11-1.
Which capital structure should be chosen: the old one from the first problem or the consultant’s?
Global Technology’s capital structure is as follows:
Debt . . . . . . . . . . . . . . 35%
Preferred stock . . . . . . 15
Common equity . . . . . 50
The aftertax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology’s weighted average cost of capital in a manner similar to Table 11-1 on page 313.
Clark Communications has a capital structure that consists of 70 percent common stock and 30 percent long-term debt. In order to calculate Clark’s weighted average cost of capital (WACC), an analyst has accumulated the following information:
? The company currently has 15-year bonds outstanding with annual coupon payments of 8 percent. The bonds have a face value of $1,000 and sell for $1,075.
? The risk-free rate is 5 percent.
? The market risk premium is 4 percent.
? The beta on Clark’s common stock is 1.1.
? The company’s retained earnings are sufficient so that they do not have to issue any new common stock to fund capital projects.
? The company’s tax rate is 38 percent.
Given this information, what is Clark’s WACC?
In a company with the following known information what is the Weighted Average Calculation of Capital (WACC): After tax cost of debt 6%, cost of preferred stock including flotation cost is 10%, cost of equity including flotation cost is 14%, and the company has a target capital structure of 50% equity, 20% preferred stock, and 30% debt. What is the company WACC?
a) 12%,
b) 10%,
c) 11.2%,
d) 9.4%,
e) 10.8%.
1. Calculate the Weighted Average Cost of Capital for the following scenario. Johnson enterprise has a capital structure of 50% bonds, 30% preferred stock, and 20% common equity stock. Their corporate tax rate is 35%. They pay the bond holders 12%. They pay the preferred stock holders 7%. The common stock holders receive 18%. Calculate the WACC.
2. Increases in dividend payment can be both positive and negative news. Explain under which conditions an increase in dividend payment can be interpreted as a signal of good news? Of bad news?
3. Your opinion on the Good, the Bad, and the Ugly of Financial Leverage.
Target capital structure 40% debt, 10% preferred, 50% common equity, interest rate on new debt 7.5%, yield on preferred is 7.0%, cost of retained earning is 11.50%, tax rate is 40%, no new stock. What is the WACC?
Exercise 1
The Director of Finance of Neolpharm Corporation needs to obtain financing for a major project expansion of the Corporation and is looking various alternatives, such as issue common Stocks, Preferred stocks and Debts (bonds). But he wants to obtain the Optimal Range of Financial Leverage. He is considering three alternatives of Investments as follow:
Alternative 1 Alternative 2 Alternative 3
Bonds (debts) 60% Bonds (debts) 25% Bonds (debts) 80%
Preferred Stocks 25% Preferred stocks 10% Preferred Stocks 5%
Common Stocks 15% Common Stocks 65% Common Stocks 15%
A. The bond financing information is as follow:
25 years bonds with face value of $10,000,000
Face Interest of 8%
Sold at Premium $10,500,000
Flotation cost of $200,000
Income tax bracket of 30%
Please calculate the cost of debt Capital
B. Cost of Preferred Stocks
Annual dividend $5.00
Preferred stock price at trading $50.00
Flotation cost of $4.00 per share
Please calculate the cost of preferred stocks
C. Cost of Common Stocks
Annual dividend per share last year $1.00
Common Stock price at trading $ 150.00
Flotation cost of $25.00 per share
Expected dividend growth Rate 8%
Please calculate the cost of Common Stock
D. Using each of the alternatives of Investments listed above and the cost of capital of debts, preferred and common stocks please calculate the Weighted Average Cost of Capital ( WACC) and provide your recommendation to Neolpharm’s Director of Finance about which is the best alternative to obtain the Optimal Range of Financial leverage. Please provide the calculation for the cost of capital and WACC.
Exercise 2
Company ABC declared a dividend of $5.00 per common stocks which market price is $100.00. What is the cost of capital if the long term expected growth in dividends is projected to be 5%.
Exercise 3
CGA Inc. has a $20,000,000 of debt outstanding with a coupon rate of 10%. The yield to maturity is 8%. If CGA tax rate is 30%, what is the cost of debt?
Metals Corp. has $2,575,000 of debt, $550,000 of preferred stock, and $18,125,000 of common equity. Metals Corp.’s after-tax cost of debt is 5.25%, preferred stock has a cost of 6.35%, and newly issued common stock has a cost of 14.05%. What is Metals Copr’s weighted average cost of capital?
a. 12.78%
b. 10.84%
c. 8.32%
d. 6.56%
Neon Corporation’s stock returns have a covariance with the market portfolio of 0.031. The
standard deviation of the returns on the market portfolio is 0.16, and the expected market
risk premium is 8.5 percent. Neon’s bonds yield 11 percent per annum. The market value of
the bonds is $24 million. Neon has 4 million shares of common stock outstanding, each worth
$15.Neon’s CEO considers the firm’s current debt-to-equity ratio optimal. The corporate tax
rate is 34 percent, and Treasury bills currently yield 7 percent per annum. Neon is considering
the purchase of additional equipment that would cost $27.5 million. The expected unlevered
cash flows (UCF) from the equipment are $9 million per year for five years. (Unlevered
cash flows are defined as the after-tax cash flows the equipment would generate under allequity
financing.) Purchasing the equipment will not change the risk level of the firm.
a. Use the weighted-average-cost-of-capital approach to determine whether or not Neon
should purchase the equipment.
b. Suppose Neon decides to fund the purchase of the equipment entirely with debt. By how
much will the weighted average cost of capital used in (a) change? Explain your answer.
Please help with the WACC problems:
The Bigelow Company has a cost of equity of 12 percent, a pre-tax cost of debt of 7 percent, and a tax rate of 35 percent. What is the firm’s weighted average cost of capital if the debt-equity ratio is .60?
2. Carter & Carter (C&C) is considering a project that requires an initial cash outlay for equipment of $6.3 million. The equipment will be depreciated to a zero book value over the 4-year life of the project. At the end of the project, C&C expects to sell the equipment for $1 million. The project will produce cash inflows of $1.5 million a year for the first 2 years and $2.2 million a year for the following 2 years. C&C has a cost of equity of 12 percent and a pre-tax cost of debt of 8 percent. The debt-equity ratio is .75 and the tax rate is 35 percent. The company has decided that they will accept the project if the project’s internal rate of return (IRR) exceeds the firm’s weighted average cost of capital (WACC) by 2 percent or more. Should C&C accept this project and why or why not?
Good Day,
Please assist with the attached question.
Regards
The directors of Jasmin Limited are considering opening a factory to manufacture a new product. Detailed forecasts of the product’s expected cash flows have been made, and it is estimated that an initial capital investment of R2.5 million is required.
The company’s current authorised share capital consists of 4 million ordinary shares, each with a nominal value of 25 cents. During the last six years the number of shares in issue has remained constant at 3 million, and the market price per share is 135 cents. The current dividend is 13.6 cents and the expected growth is 10%.
Jasmin Limited currently has in issue 800 000 8 % debentures, redeemable in four years’ time. The current yield-to-maturity is 11%.
The company also has outstanding a R900 000 bank loan repayable in five years’ time. The rate of interest on this loan is variable, being fixed at 1.5 % above the bank’s base rate which is currently 15%. The company’s tax rate is 30 %.
Required:
Calculate the weighted average cost of capital (WACC) for Jasmin Limited.
Royal Petroleum Co. can buy a piece of equipment that can be financed with debt at a cost of 9% and common equity at a cost of 16%. Assume debt and common equity each represent 50% of the firm�s capital structure.
Compute the weighted average cost of capital
I have enclosed the file with the problem aboutWeighted average cost of capital (WAACC) and Cost of common equity-DCF, that I need you help me. Also, I would like you give me the answer in excel worksheet. Thanks
10- 9 WACC
The Patrick Company’s cost of common equity is 16%, it’s before-tax cost of debt is 13%, and its marginal tax rate is 40%. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC.
Assets Liabilities and Equity Cash $120
Accounts receivable 240
Inventories 360
Long- term debt $1,152
Plant and equipment, net 2,160
Common equity 1,728
Total assets $2,880
Total liabilities and equity $2,880
10- 10 WACC
Klose Outfitters Inc. believes that its optimal capital structure consists of 60% common equity and 40% debt, and its tax rate is 40%. Klose must raise additional capital to fund its upcoming expansion. The firm will have $2 million of new retained earnings with a cost of rs = 12%. New common stock in an amount up to $ 6 million would have a cost of re = 15%. Furthermore, Klose can raise up to $ 3 million of debt at an interest rate of rd = 10% and an additional $4 million of debt at rd = 12%. The CFO estimates that a proposed expansion would require an investment of $5.9 million. What is the WACC for the last dollar raised to complete the expansion?
10- 11 WACC AND PERCENTAGE OF DEBT FINANCING
Hook Industries’ capital structure consists solely of debt and common equity. It can issue debt at rd = 11%, and its common stock currently pays a $2.00 dividend per share (D0 = $ 2.00). The stock’s price is currently $24.75, its dividend is expected to grow at a constant rate of 7% per year, its tax rate is 35%, and its WACC is 13.95%. What percentage of the company’s capital structure consists of debt?
ExSalvo, a limited partnership (whose partners are individuals in the 39.6% income tax bracket) is considering salvaging a Spanish treasure ship sunken in the Caribbean Sea. The partnership previously spent $10,000 in 1998 locating the ship and planning its recovery.
The deal requires ExSalvo to spend $50,000 now (on 1/1/99) for salvage equipment that would be immediately placed in service. The equipment is 7 year recovery property; MACRS tables list the Recovery percentages applicable in years 1 through 8 as, respectively, 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, and 4.46%. The partnership must also invest %20,000 on 1/1/00 (the end of year one or beginning of year two) in working capital (to cover the receivables on the salvage).
The forecast values of sales of salvaged treasure are also $80,000 for year one (1999) and $95,000 for year two (2000). A fee will have to be paid to the island nation closest to the sunken ship equal to 30% of the gross treasure sales each year. Other operating expense to be incurred are $20,000 for year one (1999) and $25,000 for year two (2000).
At the end of year two (12/31/00) all actual salvage activities will be terminated; all further treasure sales, island fees, operating costs, and depreciation deductions (because the equipment is no longer in services) are zero after the year 2000.
The partnership expects to spend the year 2001 (year 3) arranging to sell the salvage equipment. So on 12/31/01 ExSalvo actually receives (nets) $24,000 from a used equipment broker and liquidates its working capital investment (finally collects all of its receivables).
ExSalvo uses a 12% discount rate for similar risk projects. Use net Present Value analysis to decide whether or not ExSalvo should buy into this deal. Show your work!
If it had calculated the Internal Rate of Return (IRR) for the ExSalvo treasure deal above, would it have been less or more or less the 12% discount rate? How can you tell? Do not actually calculate the IRR.
2. Amber Inc. hires you as an analyst to calculate its weighted Average cost of capital. Amber has $5 million face value of bonds outstanding that currently trade at 92% of face value and yielding 7.25%. Amber has 100,000 shares of preferred stock outstanding that are worth $10.50/share in the market now and pay a fixed annual dividend of $1/share. Amber’s common stock is currently valued at $27/share and there are 150,000 shares issued and outstanding. The common stock currently pays a dividend of $0.20/quarter and dividends are expected to grow 12.25% compound over the foreseeable future. Amber’s marginal income tax rate is 35%. Please show your calculations for amber’s Weighted Average Cost of Capital.
How should Amber use this Weighted Average Cost of Capital number to evaluate a potential investment projects in a new venture that has a beta of .88? Assume Amber’s existing business has a beta equal to one.
Can you help me with the following project?
Capital Budgeting Case – From the given case information, calculate the firm’s WACC then use the WACC to calculate NPV and evaluate IRR for proposed capital budgeting projects with a capital rationing constraint. After you choose the project(s), recalculate the capital structure based on the assumption that the project(s) are implemented and determine if the new capital structure will signal the investors either positively, negatively, or not at all. Write a business report on your findings. Include an executive summary and appendices if applicable.
See *ATTACHED* file for complete details!
Jersey devil inc is estimating its WACC. its target capital structure is 20% debt, 20% preferred stock, and 60% equity. its bonds have a 12% coupon, paid semiannually, a current maturity of 20 yrs, and sell for $950. the firm could sell at par $100 preferred stock which pays a 12% annual dividend, but flotation costs of 5% would be incurred. Jersey Devil is a constant growth firm that just pais a dividend of $2.00 on its common stock selling for $27.00 per share. Jersey Devils constant growth rate is 8%. the firm is not expected to have to issue new common stock for its upcoming budget and therefore will rely on retained earnings for the 60% in equity that it will need. the firm marginal tax rate is 40%.
What is the firms after tax cost of debt?
what is the firms cost of preferred stock?
what is the firms cost of common stock?
what is the firms weighted average cost of capital?
Calculate the weighted average cost of capital for the following firm: it has $200000 in debt, $400000 in common stock and $10000 in preferred stock. It has a 5% cost of debt, 13% cost of common stock, 11% cost of preferred stock and a 32% tax rate.
1. 7.29%
2. 8.65%
3. 9.82%
4. 10.24%.
QUESTION 1
A. Karen Wallace currently has an investment portfolio that contains 10 stocks that have a total value equal to $160,000. The portfolio has a beta (b) equal to 1.0. Karen wants to invest an additional $40,000 in a stock with b = 2.0. After Karen adds the new stock to her portfolio, what will be the portfolio’s beta?
B. Given the following information, compute the expected return, standard deviation and coefficient of variation for Company B.:
Probability Return
0.2 2.0%
0.3 12.0%
0.5 5.0%
QUESTION 2
Your company is considering two mutually exclusive projects, X1 and X2; also considered are 2 projects, Y and Z, independant of the X projects and each other. The project costs and cash flows are shown below:
0 -$2,000 -$2,000 -$15,000 -$25,000
1 200 2,000 5,000 8,500
2 600 200 5,000 8,500
3 800 100 5,000 8,500
4 1,400 75 5,000 8,500
Projects X1 and X2 are equally risky, and the firm’s required rate of return is 12 percent. Which projects should be accepted and which should be rejected? Base your decision on any method, but justify the use of the method you have chosen.
QUESTION 3
ONE
* A company has a capital structure of 45% debt, 5% preferred stock and 50% common equity.
(a) The company can obtain unlimited debt at an interest rate of 10%. The marginal tax rate is 35%. Find the after-tax cost of debt.
(b) Preferred stock carries a dividend of $14 and currently sells for $120.00. Flotation cost on preferred stock is €10 per share. What is the cost of preferred stock?
(c) Their current stock price is $25. The next dividend is expected to be $2.56 and growth is constant at 8%. If new common stock is issued, it will have a flotation cost of 10%. Find the cost of retained earnings and the cost of issuing new common shares.
(d) If the net income is expected to be $1,600,000, and the company’s policy is to pay 50% of net income for dividends, what is the break point caused by using all of retained earnings?
(e) Find the WACC using retained earnings and the WACC when new equity is issued.
TWO
* A company has a WACC1=12.5% for funding up to $4 million when retained earnings are used. They also have a WACC2=13.7% for funding above $4 million when new equity is raised. If they have the following independent investment opportunities, which projects should the company include in their budget? What is the company’s optimal capital budget?
Project A: Cost of $2 million; IRR 20%.
Project B: Cost of $3 million; IRR 14%
Project C: Cost of $4 million; IRR 13%
5. Given the following information, calculate the weighted average cost of capital for
Situation A and Situation B:
Situation A Situation B
Capital Structure
Common Stock 55% 30%
Preferred Stock 15% 15%
Debt 30% 55%
Additional information
Corporate tax rate 30% 30%
Dividend, common $2.75 $2.75
Price, common $68 $68
Dividend, preferred 10% 10%
Price, preferred $103 $103
Bond yield 11% 11%
Bond coupon rate 13% 13%
Flotation cost, preferred $4.50 $4.50
Growth rate 7.5% 7.5%
After you have calculated both weighted average cost of capital amounts, write a response that explains why the rates are different and what the advantages and disadvantages of both alternatives are.
Conclude with which capital structure you would recommend and why you selected that structure.
Royal Petroleum Co. can buy a piece of equipment that is anticipated to provide a 9 percent return and can be financed at 6 percent with debt. Later in the year the firm turns down an opportunity to buy a new machine that would yield a 16 percent return but would cost 18 percent to finance through common equity. Assume debt and common equity each represent 50 percent of the firm’s capital structure.
Compute the weighted average cost of capital.
Which project(s) should be accepted?
11/17. Given the following information, calculate the weighted average cost of capital for Hamilton Corp.
Percent of capital structure:
Debt . . . . . . . . . . . . . . .30%
Preferred stock . . . . . . . . . 15
Common equity . . . . . . . . . . 55
please see additional info attached in the file
Collect the annual income statements of any company you know well for the last four fiscal years. The selected company must be in the process of expanding its business and plans to invest in a new investment project. As a newly hired MBA in the capital budgeting division you have been asked to evaluate a new project using the Weighted Average Cost of Capital (WACC), Adjusted Present Value (APV), and Flow-to-Equity (FTE) methods. You will need to compute the appropriate costs of capital and the net present values with each method. Because this is your first assignment with the company, they want you to demonstrate your ability to apply the different methods of project evaluation. You must seek required information necessary to determine the free cash flows. Create a spreadsheet in Excel to do all your calculations.
1-Determine the WACC for the company. Compute the NPV of the new project based on the free cash flows you calculated using the WACC method.
2-Determine the NPV using the APV and FTE methods. In both cases, assume the company maintains the target leverage ratio you computed in WACC.
3- Compare the results under the three methods and explain how the resulting NPVs are achieved under each of the three different methods.
Need APA referencing on this tutorial.
What is meant by Weighted Average Cost of Capital (WACC)?
What are the components of WACC?
Why is WACC a more appropriate discount rate when doing capital budgeting?
What is the impact on WACC when an organization needs to raise long term capital?
Consider the following data:
Percent of capital structure:
Debt 30%
Preferred stock 15
Common equity 55
Additional information:
Bond coupon rate 13%
Bond yield to maturity 11%
Dividend, expected common $3.00
Dividend, preferred $10.00
Price, common $50.00
Price, preferred $98.00
Flotation cost, preferred $5.50
Growth rate 8%
Corporate tax rate 30%
Calculate the weighted average cost of capital.
Determine the Weighted Average Cost of Capital – Please explain me this in detail.
See attached file.
Please illustrate all calculations in the yellow table below from the Excel file. Please build the formulas in the Excel sheet.
Dragon Breweries (DB) has the following balance sheet:
Dragon Breweries ($ in millions)
Fixed assets $200,000,000 Short-term debt $20,000,000
Long-term debt $80,000,000
Equity $100,000,000
Total $200,000,000 Total $200,000,000
In addition, you obtain the following information:
· The yield on the short-term debt is equal to the coupon of 3%.
· The long-term debt consists of 30-year bonds that pay an annual coupon of 7% on their $1,000 face value. Similar publicly traded bonds are currently yielding 5.5%.
· There are 5 million shares of common stock, currently trading at $30 per share. The beta is 1.2.
· The current yield on 10-year Treasury bonds is 4%, and the expected return on the S&P 500 stock index is 9%.
· DB pays taxes at a rate of 40%.
Compute the weighted average cost of capital for DB, using estimated market value weights. Please show all calculations in the table below (or one similar in format in Excel). Report returns and weights to 3 decimal places, e.g., 8% should be reported as 0.080.
The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firms’ common stock, 7.8 million shares outstanding, is now (1/1/03) selling for $65 per share, and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect pas trends to continue, g may be based on the earnings growth rate (Noted that 9 years of growth are reflected in the data.)
Year EPS Year EPS
1993 $3.90 1998 $5.73
1994 4.21 1999 6.19
1995 4.55 2000 6.68
1996 4.91 2001 7.22
1997 5.31 2002 7.80
The current interest rate on new debt is 9 percent. the firm’s marginal tax rate is 40 percent. Its capital structure, considered to be optimal, is as follows:
Debt $104,000,000
common equity 156,000,000
total liabilities and equity $260,000,000
1. Calculate Foust’s after-tax cost of new debt and common equity. Calculate the cost of equity as Ks = D1/P0 + g.
2. Find Foust’s weighted average cost of capital
I’ve figured out the after-tax cost of debt
9%(1.0 -.40)
9%(.60)
answer= 5%
Please compute the Weighted Average Cost of Capital.
for Gold Coast Homecare based on the assumptions presented in
the case. You only need to compute the overall cost of capital, not the divisional
cost of capital. You also do not need to compute the not-for-profit hospital?s home
health care business cost of capital.
Explain why the required rate of return on a firm’s assets must be equal to the weighted average cost of capital associated with its liabilities and equity. Explain.
Test: Basic Finance: A Introduction to Financial Institutions, Investments and Management. Chapter 21; page 396; problem #3.
“A firm’s current balance sheet is as follows:
Assets $100 Debt $10
Equity $90
a. What is the firm’s weighted-average cost of capital at various combinations of deb and equity, given the following information?
etc.
Your firm has expected earnings before interest and taxes of $1,700. Your unlevered cost of capital is 11% and your tax rate is 33%. You have debt with a book and a face value of $2,500. This debt has an 8% coupon and pays interest annually. What is your weighted average cost of capital?
Capital is one of the most important resources for business firms. It is important for managers to be aware of their cost of capital. To determine cost of capital, an important concept is weighted average cost of capital.
Define Weighted Average Cost of Capital (WACC).
How WACC is calculated ?
Take an example of a large and popular public company and calculate its WACC.
1. A company capital structure is
Debt……………………..35%
Preferred stock………..15%
Common equity……….50%
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (form of retained earnings) is 13.5 percent.
Calculate the weighted average cost per capital.
2. Assume that Rf = 5 percent and Km = 10.5 percent. Compute Kj for the following betas using the formula listed below.
a. 0.6
b. 1.3
c. 1.9
Formulas
Kj = Rf + B (Km – Rf)
Rf = Risk free rate of return
B = Beta coefficient ([Kj = a + BKm + e]
Kj = Return on individual common stock of a company
a = Alpha, the intercept on the y-axis
B= Beta, the coefficient
Km – Rf = Premium or excess return of the market versus the risk-free rate.
B (Km – Rf) = Expected rate of return above the risk-free rate for the stock
A corporation wants to calculate its weighted average cost of capital. It has $500 million B-rated bonds at an average rate of 5.43%, 374 million shares of common stock outstanding @ $1 par, and retained earnings of $230 million. The expected rate of return in the stock market for equities of similar risk and characteristics is 10%. What is the corporation’s WACC?
a. 5.43%
b. 7.93%
c. 10%
d. 15.43%.
OUR Corp. has a current capital structure of $18 million in secured bonds paying 6.5% annual interest, and common stock with a market value of $42 million. Its marginal tax rate is 40% and its cost of common equity capital is 13%.
a. What are the capital structure weights?
b. Calculate the company’s Weighted Average Cost of Capital.
What does calculating the weighted average cost of capital tell you about Foust company’s Financial strategy including the level of risk involved in the business?
How could the company use WACC calculations in determining future investments?
Year EPS Growth Rate
1993 3.9 7.95%
1994 4.21 8.08%
1995 4.55 7.91%
1996 4.91 8.15%
1997 5.31 7.91%
1998 5.73 8.03%
1999 6.19 7.92%
2000 6.68 8.08%
2001 7.22 8.03%
2002 7.8 8.02%
Average growth rate 8.01%
Now calculate the cost of Equity:
D1: 4.29
G: 8.01%
PO: 65
Ks: 14.61%
Cost of Debt:
Tax Rate: 40%
Interest Rate: 9%
Kd: 5.40%
B. Weight
Debt: 104,000,000 0.40
Common Equity: 156,000,000 0.60
Total: 260,000,000
WACC=We*Ke+Wd*Kd: 10.92%
Please see the attached file for the fully formatted problems.
5). Calculate the W.A.C.C. of the company and Compare to the R.O.I.C as derived from EVA.
a. Use data from the financial statements.
b. Use published interest rates on the notes to the financial statements.
c. Cost of equity estimation.
d. Example of WACC from large firms
e. Method firm uses to determine cost of Retained Earnings?
a. CAPM?
b. DCF?
c. Bond Yield Plus Risk Premium Approach?
d. Other?
INFORMATION:
Calculate the Weighted Average Cost of Capital for Solectron, Inc.
10-year bond – 10
Beta: 3.079
Required rate of return: 12.2
For the purposes of the project, utilize the Capital Asset Pricing Model (CAPM) and the Discounted Cash Flow Method (DCF) to determine the cost of retained earnings for this analytical project.
Capital Structure of Solectron
Long-term Debt $1,824.40
Preferred Stock Equity $0
Working Capital $1,718.90
Total Assets $6,529.50
Stockholder Equity $1,422.00
Total $11,494.8
*Data charted in millions
2003 2002 2001 2000 1999
Working capital $1,718.90 3,654.80 6,014.80 5,411.40 3,162.70
Total assets 6,529.50 11,014.00 13,079.90 10,375.60 5,420.50
Long-term debt 1,824.40 3,183.90 5,027.50 3,319.50 922.70
Stockholders’ equity 1,422.00 4,722.70 5,150.70 3,802.10 3,166.90
*Charted data in millions.
Stockholder Equity
2003 2002 2001
Number of shares Outstanding 64 63.2 47.9
Number of shares Exercisable 37.5 36.4 27.0
Weighted Average Exercise Price $2.29 $6.97 $17.91
Capital Expenditures
B. Break point associated with common equity. Oâ??Grady plans to use 25% long term debt in its capital structure. Every $1 in debt the firm uses, it will use $3 from other financing sources.
Total financing is then $4, because $1 comes from long term debt, its share in the total is the desired 25%.
After firm raises $700,000 in long term debt, financing source rises, the firm can raise total capital of 2.8 million in other sources to maintain the 25% for debt. 2.8 million is the break point for debt.
Firm wants to maintain 25% long term debt, wants to raise more that 2.8 million in total financing, it will require more than $700,000 in long term debt, and it will trigger the higher cost of the additional debt it issues beyond 700,000.
2. Using the break points developed in part (1), determine each of the ranges of total new financing over which the firm’s weighted average cost of capital (WACC) remains constant.
3. Calculate the weighted average cost of capital for each range of total new financing.
United Business Forms’ capital structure is as follows:
Debt-35%
Preferred stock-15%
Common equity-50
The aftertax cost of debt is 7 percent, the cost of preferred stock is 10 percent, and the cost of common equity (in the form of retained earnings) is 13 percent.
Calculate United Business Forms’ weighted average cost of capital in a manner similar to the chart below:
1 2 3
Cost Aftertax Weights Weighted Costs
Debt …………………………………………Kd ? ? ?
Preferred stock…………………………….Kp ? ? ?
Common equity (retained earnings)…..Ke ? ? ?
Weighted average cost of capital………..Ka ?
1. Promo Pak has compiled the following financial data:
(a) Calculate the weighted average cost of capital using book value weights.
(b) Calculate the weighted average cost of capital using market value weights.
In March 2007, Hertz Pain Relievers bought a massage machine that provided a return of 8 percent. It was financed by debt costing 7 percent. In August 2007, Mr. Hertz came up with a heating compound that would have a return of 14 percent. The CFO, Mr. Smith, told him it was impractical because it would require the issuance of common stock at a cost of 16 percent to finance the purchase. Is the company following a logical approach to using cost of capital?
1. Weekend Warriors, Inc., has 35% debt and 65% equity in its capital structure. The firms estimated after-tax cost of debt is 8% and its estimated cost of equity is 13%. Determine the firm’s weighted average cost of capital (WACC)?
Calculate the WACC company X using the following information:
– Debt: $75,000 book value outstanding. The debt is trading at 90% of book value. The yield to maturity is 90%.
– Equity: 2,500,000 shares seling at $42 per share. Assume teh expected rate of return on X’s stocks is 18%.
-Taxes: Company X’s marginal tax rate is Tc =0.35
Your company’s weighted average cost of capital is 11%. You believe the company should make a particular investment, but the IRR of this investment is only 9%.
What arguments might exist in support of your position?
Is it really possible that making an investment with a return below your firm’s cost of capital can ever create value?
Explain.
A firm’s current balance sheet is as follows:
Assets $100 Debt $10
Equity $90
A) What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?
B) Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take?
Assets $100 Debt $?
Equity $?
C) As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?
D) If a firm uses too much debt financing, why does the cost of capital rise?
Assume the following facts about a firm’s financing in the next year. Calculate the weighted cost of the capital of this project:
Proportion of Capital Projected funded by debt = 45%
Proportion of Capital Projects Funded by equity = 55%
Return Received by Bondholders = 0.08
Return Received by Stockholders = 0.14.
Global Technology’s capital structure is as follows:
Debt
35%
Preferred stock
15%
Common equity
50%
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology’s weighted average cost of capital ( WACC ).
A long-term bond has been issued with a market value of $50 million and an expected return of 9%. The company has 4 million shares outstanding trading for $10 each. At this price the shares offer an expected return of 17%. What is the weighted-average cost of capital for the company’s assets and operations if the company does not pay any taxes?
Please help me understand the following: (excel table attached)
Walk through key assumptions, where you got inputs for key formulas.
What did you choose as RF rate and why?
What did you choose as Market premium and why?
How did you calculate weightings of debt/equity?
Is there any Debt outstanding and if so how did you calculate current rate?
Tax rate?
Weighted Average Cost of Capital
Calculate the Weighted Average Cost of Capital for Athena Health (ATHN) for 2012 and 2013. Please show your work and list your assumptions.
Step 1 to Calculate After -tax cost of debt
After-tax cost of debt: (assume the company’s effective tax rate = 35%)
After tax cost of debt= Interest rate * ( 1- tax rate)
2013 Interest rate 2012 Interest rate
Interest rate for Athena Health= Interest 3.9 2.2% 0
Debt 173.8 0 ( As there is no debt)
2013 2012
=2.2%*(1-0.35) 0
After tax cost of debt= 1.43% 0%
http://investing.money.msn.com/investments/stock-income-statement/?symbol=US%3aATHN
http://investing.money.msn.com/investments/stock-balance-sheet/?symbol=US%3AATHN&stmtView=Ann
Step 2: Cost of equity= Risk free rate + Beta * (Market risk premium)
=2.65%+1.08*(7%)
10.21%
Note:
1) Beta taken from http://investing.money.msn.com/investments/stock-price?symbol=US%3aATHN
2) Market risk premium assumed as 7%
3) Assumed same cost of equity for both the years.
4) Risk free rate as 10 year treasury bond yiled : http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/
Step 3: Computation of WACC
For year 2013:
Value Proportion Cost Product
Debt 173.8 30.76% 1.43% 0.44%
Equity Stock 391.3 69.24% 10.21% 7.07%
Total 565.1 100% WACC= 7.51%
For year 2012:
Value Proportion Cost Product
Debt 0 0.00% 0.00% 0.00%
Equity Stock 391.3 100.00% 10.21% 10.21%
Total 391.3 100% WACC= 10.21%
Calculate the Weighted Average Cost of Capital for Athena Health (ATHN) for 2012 and 2013.
In your own words identify and briefly describe at least 6 factors that a firm can and cannot control which affect the weighted average cost of capital.
A company is funded equally by debt and equity and investors expect 12% per annum return from investing in the firms equity and 4% (net of tax) per annum to invest in its debt. What is the firms WACC? If the firm suffers a credit downgrade and investors require a return of 6% (net of tax) what is the new WACC?
Also, how does the WACC change as firms add to debt relative to equity? Why is it unreasonable to think that WACC cannot be reduced to the (original and unchanging) cost of debt itself as the proportion of debt on the balance sheet rises?
Please provide clear breakdown of answers to the above with clear/simple commentary.
The Krona Corporation is financed by 50% debt, and 50% equity. Their debt has an 8.5% annual interest rate. Their published Beta Coefficient is 1.57. The Risk Free Rate on U.S. Treasury Securities is 5% and the return on the market portfolio is 10%. Krona is not sure that they have the optimum mix of debt and equity. They are considering the following debt/equity capital structures.
1) Compute Krona’s present weighted average cost of capital.
2) Compute the weighted average cost of capital for each potential structure. Assume a 40% corporate tax rate. Should Krona change their capital structure? If so, to which of the following structures? Why? Show your all work.
a) 40% debt with an 8% coupon rate, and 60% equity
b) 60% debt with a 9% coupon rate, and 40% equity
c) 80% debt with a 10% coupon rate, and 20% equity
During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis’s cost of capital.
Please refer to attachment for more information.
If the current interest rate on new debt is 9% and the marginal tax rate is 40% and the capital structure is:
Debt: $104,000,000
Common Equity: $156,000,000
Total Liabilities and Equity: $260,000,000
How do I figure the weighted average cost of capital (WACC)?
Cost of equity is 16%; the before tax cost of debt is 13% ; the marginal tax rate is 40%.
Stock sells at book value.
I need to calculate the after tax weighted average cost of capital using the following balance sheet.
Assets Liabilities and Equity
Cash = 120 Long term debt = 1,152
Accounts receivable = 240 Equity = 1,728
Inventory = 360
Plant and equipment = 2,160
Total assets = 2,880 Total liabilities and equity = 2,880
If Firm X has a 28% cost of equity and a 10% before tax cost of debt capital. The firm’s debt to equity ratio is 2. Firm X is interested in investing in a telecom project. The corporate tax rate is 35%. What is the weighted average cost of capital for Firm X?
Please include formulas and work process so I can understand where the answer came from.
A firm plan’s to raise $4 million by borrowing at an interest rate of .16 and to raise $1 million by issuing common stock. The firm’s stock has a beta coefficient of 2, the risk free interest rate is .06, the average rate of return on stocks is .09 , the marginal tax rate is 25%. What is the composite cost of capital?
The following tabulation gives earnings per share figures for the Knerr Company during the preceding 10 years. The firm’s common stock, 7.8 million shares outstanding, is now (1/1/2003) selling for $65 per share and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 9 years of growth are reflected in the data.)
YEAR EPS
1993 $3.90
1994 $4.21
1995 $4.55
1996 $4.91
1997 $5.31
1998 $5.73
1999 $6.19
2000 $6.68
2001 $7.22
2002 $7.80
The current interest rate on new debt is 9 percent. The firm’s marginal tax rate is 40 percent. Its capital structure, considered to be optimal, is as follows:
Debt $104,000,000
Common equity $156,000,000
Total liabilities and equity $260,000,000
a. Calculate Knerr’s after-tax cost of new debt and common equity.
Calculate the cost of equity as ks = D1/P0 +g.
b. Find Knerr’s weighted average cost of capital.
See attached file for full problem description.
After tax cost of new debt and common equity….See attached file for full problem description.
A firm’s current balance sheet is as follows:
Assets
$100
Debt
$10
Equity
$90
What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?
4. (P10-9) WACC The Patrick Company’s cost of common equity is 16 percent, its before-tax cost of debt is 13 percent, and its marginal tax rate is 40 percent. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC.
Assets
Cash $120
Accounts receivable 240
Inventories 360
Plant and Equipment, net 2,160
Total assets $2,880
Liabilities
Long Term Debt $1,152
Common Equity $1,728
Total liability & equity $2,880
Question 1:
The return on the stock market as a whole is currently 9.3%. Short dated Treasury bills are currently yielding 4.12%. The Beta factor applied to returns from companies involved in the sector in which the company is considering investment projects is 1.28.
Applying the Capital Asset Pricing Model (CAPM) determine the rate of return that would be required for an investment project to be acceptable.
Question 2: Optimum PLS is a quoted company. It has 3 classes of quoted security:
a) £1,200,000 nominal value of ordinary shares at 25 pence per share. The market value of the shares is 139 pence. A dividend of 4 pence per share has just been paid. Dividends are expected to grow by 7% per annum for the foreseeable future.
b) £1,680,000 12% preference shares of £1, with a market value of 98 pence per share.
c) £2,800,000 of irredeemable debentures with a market value of £92 per £100 of debentures. The debentures have an interest rate of 8% of the nominal value.
Calculate the weighted average cost of capital (wacc) given the above capital structure.
ABC Co. is estimating its WACC. Its target capital is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semi-annully, a current maturity of 20 years, and sell for $1,000. The company could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. ABC Company’s beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. ABC Co. is a constant-growth rate of 8 percent. The firm’s policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find common stock (rs). The firm’s marginal tax rate is 40 percent.
What is ABC Co. component cost of debt?
Cost of preferred stock?
Cost of common stock (rs) using the CAPM approach?
Cost of common stock (rs) using the DCF approach?
Cost of common stock using the bond-yield-plus-risk-premium approach?
What is ABC Co. WACC?
Â?¢ The Firm has the following capital structure: (a) $100,000 in Debt, (b) $200,000 in Equity, and $50,000 in Preferred Stock.
â?¢ Financial analysts have gathered the following information about the firmâ??s common stock: (a) the dividend that was just paid was $2.00, (b) the return on the market is estimated to be 10%, (c) the risk free rate of return is estimated to be 3%, (d) the firmâ??s beta is 1.2, (e) the price of the firmâ??s stock is $30, and (f) the firmâ??s growth rate is estimated at 5%. I want to be sure that you can calculate the cost of a firmâ??s equity capital using both the CAPM and the Dividend Discount Model. Please provide your estimate for the firmâ??s cost of equity capital using both methods and select the greater of the two to use for the WACC estimate.
â?¢ The current bonds outstanding have the following characteristics: (a) 25-years until maturity, (b) they are currently priced at $800, and (c) they have coupon payments of $60.
â?¢ The companyâ??s preferred stock is paying dividends of $10.00 per share and the price of the preferred is $93.45.
â?¢ The companyâ??s tax rate is 35%.
Given the following information on T & T, Inc. capital structure, compute the companyâ??s weighted average cost of capital. The company’s marginal tax rate is 40%.
Type of Percent of Before-Tax
Capital Capital Structure Component Cost
Bonds 40% 7.5%
Preferred stock 5% 11%
Common stock (internal only) 55% 15%
XYZ Company has a target capital structure of 60% common stock, 30% debt, and 10% preferred stock. The company wishes to issue new bond ($1,000 par value) with 10% coupon rate and 30 years to maturity. The flotation costs will be $20 and the bond has to be sold at 5% discount. To issue new preferred stock the company has to pay $2 as flotation cost. The market value of preferred stock is $8 and stock will pay $1 dividend. New common stocks will cost the company $2. The expected dividend is $3 and the market value is $19 and growth rate of 5%. Tax rate is 40%.
What is the weighted average cost of capital?
Debt 35%
preferred stock 15
common equity 50
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
I need the weighted average cost of capital for Coca Cola. If you could explain how you got it and what it means to the company. Positive or negative. Thanks.
Please use the annual financial reports and not the interim ones. Thanks. Here’s the link to them.
http://www.reuters.com/finance/stocks/incomeStatement?stmtType=INC&perType=ANN&symbol=KO.N
Global Technology’s capital structure is as follows:
Debt 35%
Preferred Stock 15
Common Equity 50
The after-tax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent.
Calculate Global Technology’s weighted average cost of capital in a manner similar to Table 11-1 on page 313
Figure 11-1 Cost of capital curve
– ecampus.phoenix.edu.jpg
Capital Asset Pricing Model
Assume that Rf = 5 percent and Km = 10.5 percent. Compute Kj for the following betas, using Formula 11A-2.
a. 0.6
b. 1.3
c. 1.9
A firm’s current balance sheet is as follows:
Assets $100 Debt $10
Equity $90
What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information?
Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital
0% 8% 12% ?
10 8 12 ?
20 8 12 ?
30 8 13 ?
40 9 14 ?
50 10 15 ?
60 12 16 ?
Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Compare this balance sheet with the firm’s current balance sheet. What course of action should the firm take?
Assets $100 Debt $?
Equity $?
1. As a firm initially substitutes debt for equity financing, what happens to the cost of capital, and why?
2. If a firm uses too much debt financing, why does the cost of capital rise?
7. A firm has debt of $5,000, equity of $16,000, a cost of debt of 8%, a cost of equity of 12%, and a tax rate of 34%. What is the firm’s weighted average cost of capital?
7.29%
7.94%
8.87%
10.40%
11.05%
A firm has determined its optimal capital structure, which is comprised of the following sources and target market value proportions:
Source of capital target market proportions
Long term debt 30%
Preferred stock 5
Common stock equity 65
Debt: The firm can sell a 20 year, $1000 par value, 9 percent bond for $970. Interest is payable annually.
Preferred Stock: The firm has determined it can issue preferred stock at $65 per share. The stock will pay an $8.00 annual dividend. The cost of issuing and selling the stock is 3% per share.
Common Stock: The firm’s common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5.07. Its dividend payments have been growing at a constant rate over the last few years. Four years ago, the dividends were $3.45 per share. It is expected that to sell a new common stock issue the firm must pay 5% in flotation costs.
Additionally, the firm’s marginal tax rate is 40 percent.
What are the firm’s after tax cost of debt, cost of preferred stock, cost of a new issue of common stock, cost of retained earnings, and the weighted average cost of capital (up to the point when retained earnings are exhausted and after all retained earnings are exhausted)?
I need help with this assignment I am really lost.
With the following data, calculate the individual cost for each security and the overall WACC.
Percent of capital structure:
Debt 35%
Preferred stock 10%
Common equity 55%
Additional Information
Bond coupon rate 11%
Bond Yield to maturity 9%
Dividend, expected common $2.50
Dividend, preferred $7.00
Price, common $45
Price preferred $100
Flotation costs, preferred $5.00
Growth rate 8%
Corporate tax rate 35%
Please use the WACC formula to calculate weighted Average Cost of Capital Calculation, show me step by step so I can understand.
This solution discusses the case study ‘BCB Sports: Cost of Capital (WACC)’, prepared by Dr. D. M. Lander and B. Bouchard, in 2007.
The case study necessitates the use of the following formula:
WACC = D/V (Rd) (1-Tc) + E/V (Re) and I can use the WACC formula because this company has both debt and equity. Please advise on solution and corresponding steps to achieving solution.
(See attached file for full problem description with diagrams)
—
1. Wilson & Associates capital structure is as follows:
The after-tax cost of debt is 6.5%; the cost of preferred stock is 10%; and the cost of common equity (in the form of retained earnings) is 13.5%.
Calculate the weighted average cost of capital in a manner similar to Table 11-1 below.
Table 11-1: Cost of Capital
2. Assume that Rf = 5% and Km = 10.5%. Using the following formula:
Compute Kj for the following betas:
a. 0.6
b. 1.3
c. 1.9
Questions attached
Show all your calculations in this problem. Consider the following company. It has the following financial projections for the next two years (years 1 and 2) in millions of dollars. Assume depreciation is included in COGS.
Year 0 Year 1 Year 2
Sales Revenue — $ 1,000 $ 1,100
COGS — 600 650
SG&A — 130 120
Current Assets
Cash $ 30 $ 50 $ 50
Receivables 35 55 100
Inventories 125 200 220
Total Current Assets $ 190 $ 305 $ 370
Net Fixed Assets 640 760 700
Total Assets $ 830 $ 1,065 $ 1,070
Current Liabilities
Accrued Expenses and other
Non-Interest-Bearing Current Liabilities $ 15 $ 20 $ 60
Accounts Payable 40 45 50
Total Current Liabilities $ 55 $ 65 $ 110
Long-Term Debt 700 700 700
Equity 75 300 260
Total Liabilities and Net Worth $ 830 $ 1,065 $ 1,070
Other Data
? The current time is Year 0
? Firm’s equity β at present = 1.5
? Current debt/equity ratio market value terms = 0.25 (assume this is also the optimal capital structure)
? 50 million shares outstanding; current stock price = $18
? Tax rate = 40%
? The risk-free rate is 4% and the market equity risk premium is 7%
? Pre-tax cost of debt for firm = 8%
(1) What is the weighted average cost of capital applicable to this firm?
(2) Calculate the enterprise value of this firm at present (Year 0) using discounted cash flow analysis assuming that the free cash flow in year 2 will grow 2% per year forever.
Source of Capital Book Value Market Value After-tax cost
Long-term debt $4,000,000 $3,840,000 6.0%
Preferred stock 40,000 60,000 13.0%
Common stock equity 1,060,000 3,000,000 17.0%
Totals $5,100,000 $6,900,000
1. Calculate the weighted average cost of capital using book value weights.
2. Calculate the weighted average cost of capital using market value weights.
3. Compare the answers obtained in parts a and b. Explain the differences.
The current interest rate on new debt is9%. The firm’s marginal tax rate is 40%. It’s capital structure, considered to be optimal, is as follows:
Debt $104,000,000
Common equity $156,000,000
Total liabilities and equity $260,000,000
A. Calculate Foust’s after-tax cost of new debt and common equity. Calculate the cost of equity as D1/P0+g.
8.42/65.00+8%
B. Find Foust’s weighted average cost of capital.
Hanson Company is constructing a building. Construction began on February 1 and was completed on December 31. Expenditures were $1,680,000 on March 1, $1,260,000 on June 1, and $3,044,000 on December 31.
Hanson Company borrowed $1,167,000 on March 1 on a 5-year, 12% note to help finance construction of the building. In addition, the company had outstanding all year a 10%, 5-year, $2,598,000 note payable and an 11%, 4-year, $3,397,000 note payable. Compute the weighted-average interest rate used for interest capitalization purposes. (Round answer to 2 decimal places, e.g. 2.25.)
%_________________________
WACC= (wd)(rd)(1-Tc)+(We)(re)+(Wp)(rp)
Wd = weight of debt in a firm’s capital structure
rd = rate being paid for the firm’s use of debt monies (marginal cost)
Tc = corporate tax rate
We = weight of equity
re = rate of equity (sometimes calculated in CAPM)
Wp = weight of preferred
rp = rate being paid on preferred stock
A company has a capital structure made up of 72% common stock equity and 14% preferred stock. The rate paid to preferred shareholders is 6.71%, while cost of equity capital is 13.96%. Bondholders make up the balance of the capital structure and the marginal cost of debt is calculated at 5.35% before the firm takes into account the 38% corporate tax rate. Using these figures, please determine the WACC.
I’m confused on this problem. I know you are supposed to get the cost(aftertax), multiply by the weight to get the weighted cost. Then add the weighted costs to arrive at the weighted average cost of capital.
Smith and Jones Widget Company has total capital, consisting of long-term debt and common equity of $80 million. Thirty-two million of total capital is in the form of long-term debt, which carries a cost of 12 percent. The company’s equity carries a cost of 19.50 percent. If the company’s tax rate is 38 percent, what is the company’s WACC?
Common stock cost= ?
Debt cost= 12%
Preferred stock cost= 19.50%
Don’t you need the weights to do the calculations?
Which is not required information when calculating the weighted average cost of capital for a company with debt?
1-its capital structure ratios
2-its cost of debt
3-its current ratio
4-its tax rate
Piscataqua River Company has a 3 to 5, debt to equity ratio. The beta of its equity security is 1.75, while the overall market beta is one and overall market return for the year has been 12.15% (S&P 500). Piscataqua pays its own bond holders an overall marginal debt interest of $67.50 per year, while investing in short-term, risk-free treasury securities at 2.95% per year. The marginal tax rate of the firm is 28%. What is the weighted average cost of capital of this firm? They offer NO preferred stock at all!
7.) Hillard Corp. wants to calculate its weighted average cost of capital (WACC). The company’s CFO has collected the following information:
? The company’s long-term bonds currently offer a yield to maturity of 8%
? The company’s stock price is $32 per share (Po=$32)
? The company recently paid a dividend of $2 per share (Do=$2.00)
? The dividend is expected to grow at a constant rate of 6% a year (g=6%)
? The company pays a 10% flotation cost whenever it issues new common stock (F=10%)
? The company’s target capital structure is 75% equity and 25% debt
? The company’s tax rate is 40%
? The company anticipates issuing new common stock during the upcoming year.
What is the company’s WACC?
See the attached file.
MUST BE IN EXCEL FORMAT AND MUST SHOW ALL WORK
Ramsey Data Systems is a large company with common stock listed on the New York Stock Exchange and
bonds traded over-the counter. AS of the current blance sheet, it has three bond issues outstanding:
Expiration
$50 million of 9% series 2013
$100 million of 6% series 2010
$150 million of 4% series 2004
As the president of finance, I am planning to sell $150 million of bonds to replace the debt due to expire in
2004. Currently, the market yields on similar Baa bonds are 11.2%. Ramsey also has $60 million of 6.9%
noncallable preferred stock outstanding, and I have no intentions of selling any preferred stock at any time
in the future. The preferred stock is currently priced at $68 per share, and its dividend per share is $6.30.
While the company has had some very volatile earnings in the past, its dividends per share have had very
stable growth rate experience of 8.5% and I expect this to continue. The expected dividend is $2.10 per share,
and the common stock is selling for $60 per share. The company’s investment banker has quoted the following
floatation costs to Ramsey: $1.80 per share for preferred stock and $3 per share for common stock.
On the advise of my investment banker, I have kept the debt at 50% of assets and equity at 50%. I see no need
sell either common or preferred stock in the foreseeable future as the business has generated enough internal
funds for its investment needs when these funds are combined with debt financing. Ramsey’s corporate tax
rate is 35%.
2a. Given the information above please calculate the cost of capital for the following:
a. Bond (debt) (Kd)
b. Preferred stock (Kp)
c. Common equity in the form of retained earnings (Ke)
2b. What is Ramsey’s cost of capital for common stock?
2c. What is the weighted average cost of capital?
The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firm’s common stock, 7.8 million shares outstanding, is now (1/1/03) selling for $65 per share, and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 9 years of growth are reflected in the data.)
YEAR EPS YEAR EPS
1993 $3.90 1998 $5.73
1994 4.21 1999 6.19
1995 4.55 2000 6.68
1996 4.91 2001 7.22
1997 5.31 2002 7.80
The current interest rate on new debt is 9 percent. The firm’s marginal tax rate is 40 percent.
Its capital structure, considered to be optimal, is as follows:
Debt $104,000,000
Common equity 156,000,000
Total liabilities and equity $260,000,000
a. Calculate Foust’s after-tax cost of new debt and common equity. Calculate the cost of equity as; ks = D1/P0 + g.
b. Find Foust’s weighted average cost of capital.
The weighted average cost of capital (WACC) reflects, on the average, the firm’s cost of long-term financing. Given the costs of the specific sources of financing, how would you obtain the appropriate weights for use in calculating a firm’s WACC?
Spend a few moments considering this question
I need help in calcuating for Weighted average cost of capital.
The question go Suppose that George Industries has a cost of equity of 14%, no preferred stock and a cost of debt of 9%. If the target debt/equity ratio is 75% and the tax rate is 34%, what is Dugan ‘s weighted average cost of capital(WAAC)?
? Re ? Rd Tc
WAAC = (E/V) X 14% + (D/V) X 9% X (1-34%)
I can not fiqure what were (e/v) and (D/V) to complete the answer. Tommorrow is final exam I would like know were I am going wrong
A Company (BrainM plc) has 10 million ordinary shares of 50p each in issue out of an authorised ordinary share capital of 12 million. The company has recently paid a dividend of 12p per share on the ordinary shares, which are currently listed at 112p ex div. The dividend growth rate has recently been a little under 10% p.a., and this is expected to continue for the foreseeable future. Extracts from the group balance sheet are as follows:
BrainM plc
£000
Ordinary shares 5,000
Share premium 3,920
Reserves 7,490
Minority interests 1,790
3% irredeemable debentures 3,000
6% redeemable debentures 4,000
Bank loans 7,080
Interest on the debentures is payable annually, and both of the current year’s payments are impending. The current market prices for £100 nominal value stock are £31.50 and £103.50 for the 2% and 6% debentures, respectively (both values being cum interest). The 6% debentures are redeemable in ten years’ time at a premium of 2.5%. The bank loans currently bear interest at 2% p.a. above base rate (which is currently 3.5%) and are repayable in eight years. The effective corporation tax rate for BrainM plc is 35%.
How would I calculate the weighted average cost of capital to be used by the company in appraising the viability of the projects? Can you please explain, so i can understand how and why you come about it.
If anyone can help me, it would be much appreciated. Thank you in advanced.
If more credits are needed to solve the problem, please let me know.
Copernicus, Inc. has determined that its target capital structure will be 60% debt, 10% preferred stock, and 30% common stock. As the financial manager, the CFO has informed you that the company’s before tax cost of debt is 10%, preferred stock is 14%, and common stock is 16%. In addition, the company’s marginal tax rate is 40%. Based on the information provided, calculate the weighted average cost of capital (WACC).
Keepler, Inc. has determined that its target capital structure will be 30% debt, 15% preferred stock, and 55% common stock. Also, the company’s provides the following information:
Bond coupon rate 13% Bond yield to maturity 11%
Dividend, expected common $3.00 Dividend, preferred $10.00
Price, common $50.00 Price, preferred $98.00
Growth rate 8%
Corporate tax rate 30%
Based on the information provided, calculate the firm’s weighted average cost of capital (WACC).
1) JJ Industries currently has a capital structure that consists of 75 percent common equity and 25 percent debt. The risk-free rate is 5 percent. The market risk premium is 6 percent. JJ’s common stock has a beta of 1.2. JJ has 20 year bonds outstanding with an annual coupon rate of 12 percent and a face value of $1,000. The bonds sell today for $1,200. The company’s tax rate is 40 percent. What is the company’s current weighted average cost of capital (WACC) ?
Maple Leaf Industries, headquartered in Toronto, is a multiproduct company with three divisions: Pacific
Division, Plains Division, and Atlantic Division. The company has two sources of long-term capital:
debt and equity. The interest rate on Maple Leafâ??s $400 million debt is 9 percent, and the companyâ??s tax
rate is 30 percent. The cost of Maple Leafâ??s equity capital is 12 percent. Moreover, the market value of
the companyâ??s equity is $600 million. (The book value of Maple Leafâ??s equity is $430 million, but that
amount does not reflect the current value of the companyâ??s assets or the value of intangible assets.)
The following data (in millions) pertains to Maple Leafâ??s three divisions.
Division
Before-Tax
Operating Income
Current
Liabilities
Total
Assets
Pacific ………………………………………….. $14 $6 $ 70
Plains ………………………………………….. 45 5 300
Atlantic ……………………………………….. 48 9 480
Required:
1. Compute Maple Leaf’s weighted-average cost of capital (WACC).
2. Compute the economic value added (or EVA) for each of the company’s three divisions.
3. What conclusions can you draw from the EVA analysis?
In computing the cost of capital, do we use the historical costs of existing debt and equity or the current costs as determined in the market?
a. Historical costs
b. Current costs
The cost of debt is less than the cost of preferred stock if both securities are priced to yield 10% and the company is in the 35 percent tax bracket.
a. True
b. False
What is the aftertax cost of debt if the yield is 6% and the corporate tax rate is 16%?
a. 3.03%
b. 5.04%
c. 7.07%
d. 8.09%
If a company has preferred stock priced at $80 with annual dividends of $6 and flotation costs of $3, then the effective cost of preferred stock is:
a. 7.79%
b. 7.75
c. 7.23
d. 6.00
According to the capital asset pricing model, if the required market return is 12%, risk-free return is 5.5%, and beta is 1, then the required return on common stock is:
a. 8%
b. 10%
c. 12%
d. 14%
The cost of new common stock is lower than the cost of retained earnings, according to the text.
a. True
b. False
Maximizing the overall cost of capital represents an optimum capital structure.
a. True
b. False
Preferred stock is not a tax-deductible expense for an issuing company.
a. True
b. False
A company has the following capital structure:
? Debt 30% Cost of Debt=7.7%
? Preferred stock 15% Cost of preferred stock=10.81%
? Common stock 55% Cost of common stock=14%
Weighted average cost of capital equals:
a. 9.63%
b. 10.63%
c. 11.63%
d. 12.63%
The marginal cost of capital increases as higher-cost new common stock is substituted for retained earnings.
a. True
b. False
According to the text, stockholders definitively and conclusively prefer dividends over retained earnings.
a. True
b. False
According to the clientele effect, investors in high marginal tax brackets usually prefer companies that reinvest most of their earnings rather than pay out in dividends.
a. True
b. False
If a company pays annual dividends of $1.20 per share and has $2.40 earnings per share, then the dividend payout ratio is:
a. 40%
b. 46%
c. 50%
d. 200%
A stock split significantly increases the value of a company by generating more earnings for the company.
a. True
b. False
Theoretically, a stock repurchase program can be an equivalent alternative to a cash dividend, assuming no tax advantages according to the text.
a. True
b. False
Dividend reinvestment plans allow corporations to raise funds continually from present stockholders.
a. True
b. False
The shares of the Charles Darwin Fitness Centers sell for $60. The firm has a P/E ratio of 20. Forty percent of earnings are paid out in dividends. What is the firm’s dividend yield?
a. 8%
b. 6%
c. 4%
d. 2%
A convertible security is a bond or share of preferred stock that can be converted, at the option of the holder, into common stock
a. True
b. False
Interest rates on convertibles are lower than those on straight debt issues.
a. True
b. False
Derivative securities such as options and futures can be used by corporate financial managers for hedging activities.
a. True
b. False
The effect of tax rate on WACC. Equity Lighting Corp. wishes to explore the effect on its cost of capital of the rate at which the company pays taxes. The firm wishes to maintain a capital structure of 30% debt, 15% preferred stock, and 55% common stock. The cost of financing with retained earnings is 17%, the cost of preferred stock financing is 11% and the before tax cost of dbt financing is 7%. Calculate the weighted average cost of capital (WACC) given a tax rate of 35%.
Please see attached document.
Ember is considering an investment of $40 million in plant and machinery. This is expected to produce free cash flows of $13 million in year 1, $14 million in year 2, $15 million in year 3, and 25 million in year 4. The tax rate is 35%. You don’t know the target capital structure, but you do have the following information:
– Bonds: There are 37,000 bonds with a 5.5% coupon outstanding. The coupons are paid annually. The bonds have a 1000 face value and 8 years to maturity. They sell for 96.7% of par.
– Retained Earnings (Internal Equity): There are 950,000 shares outstanding with a price of $55 per share. The beta on the stock is 1.25. The risk-free rate is 2% and the market risk premium is 6%.
a) Calculate the weighted average cost of capital. Hint: To get the weights, you will need to solve for the market value of the debt and equity.
b) Calculate the net present value (NPV) with the WACC.
c) Should they invest? Why or why not?
The following tabulation gives earnings per share figures for the Foust Company during the preceding 10 years. The firm’s common stock, 7.8 million shares outstanding, is now (1/1/03) selling for $65 per share, and the expected dividend at the end of the current year (2003) is 55 percent of the 2002 EPS. Because investors expect past trends to continue, g may be based on the earnings growth rate. (Note that 9 years of growth are reflected in the data.)
YEAR EPS YEAR EPS
1993 $3.90 1998 $5.73
1994 4.21 1999 6.19
1995 4.55 2000 6.68
1996 4.91 2001 7.22
1997 5.31 2002 7.80
The current interest rate on new debt is 9 percent. The firm’s marginal tax rate is 40 percent. Its capital structure, considered to be optimal, is as follows:
Debt $104,000,000
Common equity 156,000,000
Total liabilities and equity $260,000,000
a. Calculate Foust’s after-tax cost of new debt and common equity. Calculate the cost of equity as ks _ D1/P0 _ g.
b. Find Foust’s weighted average cost of capital.
Company has a target capital structure of 40% debt, 10% preferred stock, and 50% common equity. The company’s after tax cost of debt is 8%, its cost of preferred debt is 10%, its cost of retained earnings is 14%, and its cost of new common stock is 16%. The company stock has a beta of 1.2 and the company’s marginal tax rate is 35%.
What is the company’s weighted average cost of capital if retained earnings are used to fund the common equity portion?
(See attached file for full problem description)
Please see attached problem…
Prepare responses to the questions posed by the “What’s on the Web?” exercises 12.1, 12.2 (in 12.2 you can find the beta for Dell by going to the web site yahoo.finance.com under Stock Price History), 12.3 (for simplicity assume that the company’s long-term debt consists of $200 million in long term bonds and $300 million in debentures, assume the book value and market value of the Dell debentures are the same and that the coupon rate is also the yield to maturity). You can figure out the market value of the $200 million Dell bonds by multiplying the book value by the Price column value found in www.bondsonline.com and 12.4 found at the end of Chapter 12 of the text. Your end product of these exercises will be the Dell Computer’s WACC. Include exhibits that show all of the calculations used to calculate Dell’s WACC.
b. Describe the implications of WACC in relation to Dell’s goal of shareholder wealth maximization. Include a brief discussion of how internal and external factors can impact the organization’s WACC.
A firm has determined its cost of each source of capital and optional capital structure which is composed of the following sources and target market value propositions:
Sources of Capital Target Market After-tax cost
Propositions
Long-term debt 40% 6%
Preferred Stock 10 11
Common stock equity 50 15
The weighted average cost of capital is:
A. 15%
B. 10.7%
C. 11%
D. 6%
Here is a condensed version of your firm’s balance sheet:
Total Liabilities $30, 000, 000
Preferred Stock 10, 000, 000
Common Stock 60, 000, 000
Total Assets $100, 000, 000 Total Liabilities & Equity $100, 000, 000
If your firm’s aftertax cost of debt is 6%, the cost of preferred stock is 10%, and the cost of common stock is 11%, what is the Weighted Average Cost of Capital (WACC)?
Let’s try calculating the weighted average cost of capital (WACC). Calculate the WACC given the following assumptions: a. Company tax rate is 40 percent. b. Company has an outstanding bond issue with a 7-7/8 coupon, market price of 103-5/8 (percent of 100% par, in 32nds.), semiannual coupon payments, and 12 years to maturity. c. Company has an outstanding preferred stock issue paying an 8 percent dividend, $100 par, and a market price of $98.35. Flotation (issuance) costs on a new issue are 8 percent. d. Common equity financing is through retained earnings. The Company has a beta of 1.22. The market risk premium is 6 percent and the risk-free rate is 4 percent. The company’s capital structure is 40 percent debt, 10 percent preferred, and 50 percent common equity.
Can you please explain in detail how to do this problem so that I may learn how to do it? Also, is there a function in Excel that calculated this?
. Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock.
? The company can issue bonds at a yield to maturity of 8.4 percent.
? The cost of preferred stock is 9 percent.
? The company’s common stock currently sells for $30 a share.
? The company’s dividend is currently $2.00 a share (D0 = $2.00), and is expected to grow at a constant rate of 6 percent per year.
? Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued.
? The company’s tax rate is 30 percent.
What is the company’s weighted average cost of capital (WACC)?
a. 8.33%
b. 9.32%
c. 9.79%
d. 9.99%
e. 13.15%
ABC company currently has the following capital structure: 30% debt and 70% equity based on market values. Company’s equity beta based on its current level of debt financing is 1.20 and its debt beta is 0.30. Risk free rate of interest is currently 2.5% on long-term government bonds. The company’s pre-tax cost of debt is 5%. The market risk premium is 7.5%.
1. What is your estimate of the cost of equity capital for the company based on the CAPM?
2. If company’s marginal tax rate is 35%, what is the firm’s overall weighted average cost of capital?
3. The company considers acquiring a Solar Energy arm to expand its current business operations. The new division will be relatively independent and it will issue its own debt constituting 45% of total assets of the division. Nevertheless, the firm’s investment banker estimates that the company will be able to and maintain its current credit rating and borrowing cost. Analysts usually report that unlevered betas in all energy sectors are the same. Estimate the WACC for the division.
Consider the data on the following data, calculate the individual costs for each security and the weighted average cost of capital. Then comment on your findings.
Percent of capital structure:
Debt 30%
Preferred stock 15
Common equity 55
Additional information:
Bond coupon rate 13%
Bond yield to maturity 11%
Dividend, expected common $3.00
Dividend, preferred $10.00
Price, common $50.00
Price, preferred $98.00
Flotation cost, preferred $5.50
Growth rate 8%
Corporate tax rate 30%
Consider the data on the following data, calculate the individual costs for each security and the weighted average cost of capital. Then comment on your findings.
Percent of capital structure:
Debt 30%
Preferred stock 15
Common equity 55
Additional information:
Bond coupon rate 13%
Bond yield to maturity 11%
Dividend, expected common $3.00
Dividend, preferred $10.00
Price, common $50.00
Price, preferred $98.00
Flotation cost, preferred $5.50
Growth rate 8%
Corporate tax rate 30%
Problem 12:
Given the following data:
Percent of capital structure:
Debt 40%
Preferred stock 10
Common equity 50
Additional information:
Bond coupon rate 12%
Bond yield to maturity 13%
Dividend, expected common $4.00
Dividend, preferred $12.00
Price, common $60.00
Price, preferred $78.00
Flotation cost, preferred $7.50
Growth rate 21%
Corporate tax rate 30%
Calculate the individual capital costs for each security and the weighted average cost of capital.
Is it important to know your company’s WACC? Why or why not? How might management decisions impact the WACC? To what extent is your company’s WACC uncontrollable?
Question 1: In what sense is the WACC an average cost? A marginal cost?
Question 2: A company’s 6% coupon rate, semiannual payment, $100 par value bond that matures in 30 years sells at a price of $515.16. The company’s federal-plus-state tax rate is 40%. What is the firm’s component cost of debt for purposes of calculating the WACC? (hint: Base your answer on the minimal rate.) Please provide your solution with the steps. Financial calculator should be used.
Question 3: Explain why the NPV of a relatively long-term project, defined as one for which a high percentage of its cash flows are expected in the distant future, is more sensitive to changes in the cost of capital than is the NPV of a short-term project.
Question 4: A project has an initial cost of $52, 125, expected net cash inflows of $12,000 per year for 8 years, and a cost of capital of 12%. What is the project’s NPV?
A company has determined that its optimal capital structure consists of 30 percent debt and 70 percent equity.
Given the following information, calculate the firm’s weighted average cost of capital.
Rd = 6%
Tax rate = 35%
P0 = $35
Growth = 0%
D0 = $3.00
Summary of the balance sheet of XYZ below
Balance sheet of XYZ as at 31 December 2009 (‘000)
Cash R10 Account payable R10
Accounts receivable 20 Acruals 10
Inventories 20 Short-term debt 5
Current assets R50 Current liabilities R 25
Net fixed assets 50 Long term debt 30
Preference shares 5
Ordinary equity
Ordinary shares 10
Retained earnings 30
Total(ordinary) equity 40
Total assets R100 Total liabilities and equity R100
The following facts are also given for XYZ:
(i) Short-term debt consists of bank loans that currently cost 10
percent, with interest payable quarterly. These loans are used to
finance receivables and inventories on a seasonal basis, so in
the off-season, bank loans are zero.
(ii) The long-term debt consists of 20-year, semi-annual payment
bonds with a coupon rate of 8 percent. Currently, these bonds
provide a yield to investors of Rd = 12 percent. If new bonds
were sold, they would yield investors 12 percent. If new bonds
were sold, they would yield investors 12 percent.
(iii) A XYZ preference share has a R100 par value, pays a
quarterly dividend of R2, and has a yield to investors of 11
percent. New preference shares would have to provide the same
yield to investors, and the company would incur a 5 percent
flotation cost to sell it.
(iv) The company has 4 million ordinary shares outstanding. The
shares have recently traded in a range of R17 to R23 with Po =
R20 as the most likely current price. Do = R1 and EPSo = R2.
ROE based on average equity was 24 percent in 2008, but
management expects to increase this return on equity to 30
percent; however, security analysts are not aware of
management’s optimism in this regard.
(v) Beta coefficients for XYZ, as reported by security analysts,
range between 1,3 to 1,7. A Beta coefficient of 1,5 seems the
most likely value. The T-bill rate is 10 percent, and rM is
estimated by various brokerage houses to be in the range of
14,5 to 15,5 percent.
(vi) XYZ is in the 40 percent tax bracket.
(viii) XYZ’s investment banker, predicts a decline in interest rates,
with rd falling to 10 percent and the T-bill rate to 8 percent,
although XYZ’s investment banker acknowledges that an
increase in the expected inflation rate could lead to an increase
rather than a decrease in rates.
(ix) Growth in dividends, as estimated by the retention growth model
[g = b(r)] is 12 percent.
Based on the information provided, you are required to estimate the
company’s Weighted Average cost of Capital (WACC). Assume that no
new equity will be issued. Your WACC estimate should be appropriate for
use in evaluating projects which are in the same risk class as the firm’s
average assets now on books.
An interest payment of $650 in a 20 percent tax bracket would result in a tax saving of what?
Joe Morton buys a piece of equipment for $200,000. He puts down $40,000 and finances $160,000. Joeâ??s opportunity cost is 4%, and the lenderâ??s interestâ??s rate is 8%. Find the weighted average cost of capital (WACC).
Please assist with the following statements and question:
There are few ways to compute the weighted average cost of capital for a company: Of course one first estimates the ‘cost’ (in percentage terms) of the three main sources of capital: short term debt or liabilities, long term debt or liabilities and the cost of equity, and then computes the WACC using ‘appropriate weights’ as follows:
(1) Use the balance sheet of ‘book values’ of the different sources of capital as the ‘weights’.
(2) Use the market value of short term debt (or liabilities), long term debt (or liabilities) and the market value of equity as ‘weights’
(3) Use the “Target Capital Structure” of the company as the ‘weights’.
Which of the three approaches should be adopted? Why?
Thanks in advance for your time and assistance!
For this problem what the debt and equity has to do with the rd?
A company has determined that its optimal capital structure consists of 40% debt and 60% equity. Assume the firm will not have enough retained earnings to fund the equity portion of its capital budget, and the cost of capital is adjusted to account for flotation costs. Given the following information, calculate the firm’s WACC.
– rd = 8%.
– Net income = $40,000.
– Payout ratio = 50%.
– Tax rate = 40%.
– P0 = $25.
– Growth = 0%.
– Shares outstanding = 10,000.
– Flotation cost on additional equity = 15%.
Just need some direction here.
The Adams company cost of common equity is 16 percent, its before tax cost of debt is 13 percent, and its marginal tax rate is 40 percent. The stock sells at book value. Using the following balance sheet, calculate the Adams’ Weighted Average Cost of Capital.
Assets:
cash $120
accounts receivable $240
inventories $360
plant and equipment, net $2,160
Total Assets $2,880
Liabilities and Equity:
long term debt $1,152
common equity $1,728
Total Liabilities and Equity $2,880
What is the Weighted Average Cost of Capital? How it is used in a capital investment program to select investments?
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