# Berkshire Instruments

758 Words Sep 6th, 2011 4 Pages
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Berkshire Instruments

Group No. 1
Alsim, Allan Patrick
Belgica, Robie
Escaño, Ergo
Galang, Roberto
Villanueva, Jill
Borlong, Li (Michael)

SPFINMAN / G05

Prof. Alan Jezrel Solomon, MBA

1. Determine the Weighted Average Cost of Capital (WACC) based on using retained earnings in the capital structure.

In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.

Cost of Debt – To find the cost of debt, we use the details of the bonds issued by Rollins Instruments.
The bonds have 20 years to maturity, pay interest at 9.3%, have a par value of \$1,000 and are currently selling for \$890.
The cost of debt is the yield to
The formula is
Cost of Equity = D1/MP + g
Where D1 is the expected dividend
MP is the market price g is the dividend growth rate
D1 is given as 3X40% = \$1.20
MP is \$25
For g, we are given that the dividend has grown from \$0.82 to \$1.20 in four years. We use the compound interest formula to get the growth rate
1.20 = 0.82 X (1+g) ^4. This gives the value of g as 10%
Cost of Equity = 1.20/25 + 10% = 14.8%
The proportion of equity is 10,080,000/18,000,000=60%.
We do not use the floatation cost here, since retained earnings are internally generated and not to be raised.

WACC = Cost of Debt X proportion of debt + Cost of Preferred Stock X Proportion of preferred stock + Cost of equity X proportion of equity
WACC = 6.92%X0.34 + 8.36% X 0.06 + 14.8% X 0.60
WACC = 11.73%

2. Recompute WACC using new equity

When new equity is to be raised, then there will be floatation cost. The net price will be \$25-\$2 the floatation cost = \$23.
Cost of Equity = 1.20/23 + 10% = 15.2%
The new WACC is
WACC = 6.92%X0.34 + 8.36% X 0.06 + 15.2% X 0.60
WACC = 11.97%
Retained Earnings are \$4,500,000
The proportion of equity in total capital structure is 60%
The increase in cost of capital will take after 4,500,000/60%=\$7,500,000 of new financing.

3. Using CAPM to calculate the cost of equity.

The cost of equity is given as
Cost of Equity = Risk free rate + (Market return – risk free rate) X beta
Give