Busn Essay

b. How did you measure the cost of debt for each division? Should the debt cost differe across divisions? Why?

Calculate the after tax cost of debt using the following information (hint: see page 285 in text).

4. Why is the coupon rate of existing debt irrelevant for finding the cost of debt capital?

Yield to Maturity, the book yield or redemption yield of a bond or other fixed-interest securities, is the internal rate of return an investor will earn when he purchases the bond today at the market price, provided that the bond is held until maturity and that all coupon and principal payments are made on schedule. (Fabozzi, 2007) Taking into account the clean price of some of the securities and using the YTM formula in Excel, YTM of various on-the-run Treasury bonds are obtained.

For each outstanding debt, we calculated interest payments until maturity. We then applied the 48% tax rate on interest to obtain the value of ITS and discounted each of the ITS figures at the appropriate cost of debt

As I mentioned, there are two types of debt and consequently we have two types of Cost of Debt. I calculated the weight average for Cost of debt as follows:

10. The board of directors of the General Wheels Co. is considering seven large capital investments. These investments differ in the estimated long-run profit (net present value) they will generate, as well as in the amount of capital required, as shown by the following table (in units of millions of dollars). Investment Opportunity 1 2 3 4 5 Estimated profit Capital required 17 43 10 28 15 34 19 48 7 17

In-The-Dell Farm issued 30-year, 8 percent semiannual bond 7 years ago. The bond currently sells for 108 percent of its face value. The company’s tax rate is 35 percent.

ABC Company is a manufacturing firm that specializes in making cedar roofing and siding shingles. The company currently has annual sales of around $1.2 million, which is a 25% increase from the previous year. The company has a very aggressive growth target of reaching $3 million annual sales within the next three years. The CEO of ABC Company would like to begin a new project, using some of the shingle scrap materials to build cedar dollhouses, this opportunity could help ABC Company in reaching those growth targets. The new dollhouse product line would be able to leverage ABC Company’s existing manufacturing facilities and the current staff, but the project will add additional raw materials and be more time-intensive to manufacture than current products. As the corporate controller I have created this report that will provide the necessary details about the estimated product costs, the amount of sales that is needed to break even on the project, and what level of return this product is expected to provide.

300 Year 4 300 Year 5 300 Year 6 300 YTM calculation assumes that coupon payments will be reinvested over time at the same level Future Value Analysis Time Cash-Flows All cash-flows referenced to Year 6.

When management of a company is deciding on developing a new product or process, buying a new machine or a new building, or acquiring an entire company, the goal is to earn a satisfactory return on their investment. The process of analyzing long-term investments and deciding

The input data will consist of yields to maturity and respective time to maturity of the sample bonds. The independent (explained) variable in this model will be the yield to maturity. The explanatory variables will consist of the bonds’ time to maturity at the power of 1, 2 and 3 respectively.

As such, the expected service from the machine is a total of 7 years, with a goal of achieving revenue of $25 million by 2015, three years from the investment is introduced to the organization. The organization expects a 10% return on investments with an 8% cost on capital. This paper seeks to evaluate if the purchase would lead to organizational success or steer the organization into a financial pitfall. As such, evaluation of this investment is crucial for the success of the business. A complete investment analysis using the aforementioned techniques is conducted below.

ABC Company is planning to introduce the new product line which would utilize the spare manufacturing capacity. The product line will add up additional raw material, more time intensive labor but it will also provide higher revenue and gross margin to reach growth targets. The product will need advertising and sales promotion activities to promote customer awareness. The company will have to plan strategies satisfying the competition in market. As the product is new, initially it will cost more, the company should analyze other revenue sources to meet the cost of expansion. The risk that should be taken into consideration with the project would be the ability to have an adequate cash flow to justify the $42,000- investment for the equipment purchased.

a. Based upon the cost of capital approach, what is the optimal debt ratio for your firm?