Order from us for quality, customized work in due time of your choice.
THE FOLLOWING INFO IS THE SAME ONE AS THE ONE YOU’LL FIND IN THE ATTACHED FILE. I’M JUST COPYING AND PASTING DIRECTLY FROM THERE, SO PLEASE USE THE ATTACHED FILE AS IT’S A MUCH EASIER WAY TO SEE ALL THE INSTRUCTIONS IN AN ORGANIZED MANNER.
INSTRUCTIONS:
Please Add Cover Page with appropriate information
Residency Activity 3:
Concepts:
Cost of Capital focusing on Weighted Average Cost of Capital (WACC)
Example 1: Cost of Common Stock using CAPM
The Nixon Corporation’s common stock has a beta of .95. If the risk-free rate is 2.7 percent and the expected return on the market is 10 percent, what is the company’s cost of equity capital?
Comments:
With the information given, we can find the cost of equity using the CAPM. The cost of equity is:
RS = .027 + .95(.10 − .027)
RS = .0964, or 9.64%
Example 2: Cost of After-tax of Debt
One Step, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 6 percent.
What is the company’s pretax cost of debt?
If the tax rate is 21 percent, what is the after-tax cost of debt?
Comments:
The pretax cost of debt is the YTM of the company’s bonds, so:
P0 = $950 = $30(PVIFAR%,34) + $1,000(PVIFR%,34)
R = 3.245%
RB = 2 × 3.245%
RB = 6.49%
And the aftertax cost of debt is:
Aftertax cost of debt = .0649(1 − .21)
Aftertax cost of debt = .0513, or 5.13%
Example 3: Capital Structure and WACC
Hero Manufacturing has 7.6 million shares of common stock outstanding. The current share price is $67 and the book value per share is $4. The company also has two bond issues outstanding. The first bond issue has a face value of $80 million and a coupon rate of 6.8 percent and sells for 109.5 percent of par. The second issue has a face value of $65 million and a coupon rate of 7.1 percent and sells for 112.4 percent of par. The first issue matures in 9 years, the second in 25 years.
Suppose the company’s stock has a beta of 1.10. The risk-free rate is 2.9 percent and the market risk premium is 7 percent. Assume that the overall cost of debt is the weighted average implied by the two outstanding debt issues. Both bonds make semiannual payments. The tax rate is 23 percent. What is the company’s WACC?
Comments:
The market value of equity is the share price times the number of shares, so:
S = 7,600,000($67)
S = $509,200,000
Using the relationship that the total market value of debt is the price quote times the par value of the bond, we find the market value of debt is:
B = 1.095($80,000,000) + 1.124($65,000,000)
B = $160,660,000
This makes the total market value of the company:
V = $509,200,000 + 160,660,000
V = $669,860,000
And the market value weights of equity and debt are:
S/V = $509,200,000/$669,860,000
S/V = .7602
B/V = 1 – S/V = .2398
Next, we will find the cost of equity for the company. The information provided allows us to solve for the cost of equity using the CAPM, so:
RS = .029 + 1.10(.07)
RS = .1060, or 10.60%
Next, we need to find the YTM on both bond issues. Doing so, we find:
P1 = $1,095 = $34(PVIFAR%,18) + $1,000(PVIFR%,18)
R = 2.725%
YTM = 2.725% × 2
YTM = 5.45%
P2 = $1,124 = $35.50(PVIFAR%,50) + $1,000(PVIFR%,50)
R = 3.062%
YTM = 3.062% × 2
YTM = 6.12%
To find the weighted average aftertax cost of debt, we need the weight of each bond as a percentage of the total debt. We find:
XB1 = 1.095($80,000,000)/$160,660,000
XB1 = .545
XB2 = 1.124($65,000,000)/$160,660,000
XB2 = .455
Now we can multiply the weighted average cost of debt times one minus the tax rate to find the weighted average aftertax cost of debt. This gives us:
RB = (1 – .23)[(.545)(.0545) + (.455)(.0612)]
RB = .0443, or 4.43%
Using these costs and the weight of debt we calculated earlier, the WACC is:
RWACC = .7602(.1060) + .2398(.0443)
RWACC = .0912, or 9.12%
Complete The following Problem. To earn full or partial marks, you must all your calculations in good gorm
Capital Structure and WACC: The Saunders Investment Bank has the following financing outstanding.
Debt:
40,000 bonds with a coupon rate of 4.9 percent and a current price quote of 106.5; the bonds have 15 years to maturity and a par value of $1,000. 40,000 zero coupon bonds with a price quote of 21.8, 30 years until maturity, and a par value of $10,000. Both bonds have semiannual compounding.
Preferred stock:
135,000 shares of 3.5 percent preferred stock with a current price of $87 and a par value of $100.
Common stock:
1,900,000 shares of common stock; the current price is $73 and the beta of the stock is 1.15.
Market:
The corporate tax rate is 23 percent, the market risk premium is 7 percent, and the risk-free rate is 3.6 percent.
What is the WACC for the company? Show all calculations in good form.
As a group, discuss how you would use WACC in a capital project investment decision. Support your comments with appropriate APA references.
Order from us for quality, customized work in due time of your choice.