Case 54 Questions

WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity)

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

One of them is CAPM. However, Linda wants to calculate the cost of common equity by growth rate. In order to calculate, we need to know growth rate of dividend, last year dividend amount and stock price. At the very beginning, I calculate the dividend amounts for last 10 years by multiplying Earning per Share by dividend payout ratio (0.3). Then, I find out the average of the growth rate for last 10 years to use that rate as company’s growth rate (Table 1). The reason for finding adjusted dividend is that it is not possible for company to have negative dividend. It is expected the company’s growth rate would be 125 percent of that experienced from 1988 to 1998. So, I found growth rate as 7.799%. So,

There are many factors that businesses have to include when calculating WACC, common stock, preferred stock, bonds and long-term debt. The cost of capital for businesses has been very low because of the low interest rate policy by the feds; WACC impacts the value of corporations (Mewes, 2015). The formula to calculate the Weighted Average Capital is:

The debt/equity ratio for Boeing is provided in exhibit 10, 0.525, from where we can infer the weights of both debt and equity.

Chandler knew that the maximum value of the firm was achieved when the weighted average cost of capital was minimized. Thus she intended to estimate what the cost of equity and the wacc might be if wrigley pursued this capital structure change. The projected cost of debt would depend on her assessement of wrigley’s debt rating after recapitalization and on current capital market rates.

Subject: Cost of capital − cost of equity and cost of debt; beta risk; estimation; capital structure. The task for students is to evaluate the 777 against a financial standard, the investors’ required rate of return. The general objective of this case is to exercise students’ skills in estimating corporate (divisional/project) costs of capital – cost of equity and WACC. Case Questions, Analysis, and Directions: Read and analyze the case, and prepare an “Executive Summary” of this case. Write it as if you were writing it to the members of Boeing’s Board of Directors, who may not know much about the project or finance. Your Executive Summary will include: (1) A brief

Answer: WACC covers computation of SIVMED’s cost of capital in which each category of capital is proportionately weighted. All capital basis - common stock, preferred stock, bonds or any other long-term borrowings – should be listed under SIVMED’s WACC. We determine WACC by multiplying the cost of the corresponding capital component by its proportional weight and then adding: where: Re is a cost of equity Rd is a cost of debt E is a market value of the firm's equity D is a market value of the firm's debt V equals E + D E/V is a proportion of financing that is equity

After $1,500,000 we would have to raise new equity and so there would be flotation cost

| See Chapter 9.Last dividend (D0)         $1.00Long-run growth rate     5.4%Required return             11.4%D1 = D0(1 + g) =          $1.054P0 = D1/(rs - g)             $17.57

1. How firms estimate their cost of capital: The WACC for a firm is 13.00 percent. You know that the firm’s cost of debt capital is 10 percent and the cost of equity capital is 20% What proportion of the firm is financed with debt?

Corporate Finance ADM 3350 M & P (Winter 2015) Assignment 1 Due Date: February 23, 2015 Question 1 (5 Marks) Varta Inc. has just issued a dividend of $1.50 per share on its common stock. The company paid dividends of $1.10, $1.15, $1.25, and $1.37 per share in the last four years. The stock currently sells for $48. a. What is your best estimate of the company's cost of equity capital using the arithmetic average growth rate in dividends? b. What if you use the geometric average growth rate? Solution: (3 + 2 = 5 Marks)

Dividend Growth Method Common Stock Price (P) Forecasted Dividend (D) 4 = 0.06 Cost of Equity = (D / P) + g = (4 / 42.625) + 0.06 = 15.4% Security Market Line Method Beta (β) Risk free rate (Rf) Treasury Bill Market risk premium (Rm) = = = = 1.2 90 – day 6.4% 15% = = $ 42.625 $ 4.00

The task by Ms. Mortensen to compute the weighted Cost of Capital (WACC) is vital in attaining four objectives: (1) to support financial accounting and capital budgeting decisions, (2) for performance assessments, (3) to inform merger and acquisition proposals, and (4) to support stock-repurchase proposals. But the cost of capital approximations by Ms. Mortensen appears to misguide these decisions. This is because the inputs and assumptions are misleading as evidenced by criticism by the controllers and division

Wrigley’s prerecapitalization WACC is 10.9%. The cost of equity assumes a risk-free rate of 5.65% for 20-year U.S. Treasuries (case Exhibit 7), a risk premium is assumed 7% (or 5%), and uses Wrigley’s current beta of 0.75 (case Exhibit 5).