Case 54 Questions

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Questions 1. a. Discuss the specific items of capital that should be included in the WACC. The WACC calculation should include all the sources of capital like common stock, preferred stock, bonds and any other long-term debt. b. The comptroller currently finds the weights for the weighted average cost of capital (WACC) from information from the balance sheet shown in Table 2. Compute the book value weights that the comp­trol­ler currently uses for the company’s capital structure. (In Millions) c. Based on the suggestion that the focus should be on market values, compute the weights of debt, preferred stock, and common stock. (In Millions) MV $ MV % LT Debt 48.36 19.5% Preferred 10.00…show more content…
Explain. e. What are some alternative ways to obtain a market risk premium for use in a CAPM cost-of-equity calculation? Discuss both the possibility of obtaining estimates from outside organizations and also ways which Ace could calculate a market risk premium itself. 6. a. What is Ace’s discounted cash flow (DCF) cost of retained earnings? b. Suppose Ace, over the last few years, has had an 18 percent average return on equity (ROE) and has paid out 20 percent of its net income as dividends. Under what conditions could this information be used to help estimate the firm’s expected future growth rate, g? Estimate ks using this procedure for determining g. c. What was the firm’s historical dividend growth rate using the point-to-point method? Using the linear regression method? 7. Use the bond-yield-plus-risk-premium method to estimate Ace’s cost of retained earnings. 8. Based on all the information available, what is your best estimate for ks? Explain how you decided what weight to give to each estimating technique. 9. What is your estimate of Ace’s cost of new common stock, ke? What are some potential weaknesses in the procedures used to obtain this estimate? 10. a. Compute Ace’s WACC’s based on the company’s target capital structure and construct the marginal cost of capital (MCC) schedule. How large could the company’s capital budget be before it is forced to sell new common stock? Ignore depreciation at this point. b. Would
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