Cost of Capital Mini Cases

The company will incur floatation since before tax cost of the new debt will be higher than 8%. It can be included in calculating the cost of debt but these costs are reduced for taxable issuers and therefore can be expensed over the life of the issue.

a. What is the CD’s value at maturity (future value) if it pays 10 percent annual interest?

Telus needs to calculate the cost of capital from the variety of data given. The cost of capital is determined mostly by how the funds are used rather than where they were obtained from. It relies on the risk of investments Telus involves in, therefore, depending on cost of both equity of debt as described below. Also note that, even though the preferred shares are not attractive to issuers and may not get issued again, it is still on the company’s balance sheet and affect firm’s overall wealth.

- The Bet-r-Bilt Company has a 5-year bond outstanding with a 4.30 percent coupon. Interest payments are paid semi-annually. The face amount of the bond is $1,000. This bond is currently selling for 93 percent of its face value. What is the company's pre-tax cost of debt?

= 299.629. Notice, that the value of the firm with debt overhang is lower than the same problem without debt overhang in part (e). (h) Suppose the firm were to hedge. Would equity holders take the gamble and what would be the value of the firm? (10 points) Answer: If the firm were to hedge by selling gold in a forward contract, it would get a sure cash flow of $350. Then it would not not take the gamble, because even if it lost, it could still make the debt payment of 250 · (1.05) = 262.5 and taxes of .4(50 − 250 · .05) = 15 (we assume the debt is safe, and therefore has a yield of 0.05, and verify that it can make the payment).

d. How valid in an estimate of the cost of debt based on 15 year bonds if the corporation normally issue 30 year long term debt? The estimate is not exactly valid because coupon rates differ for 15- and 30-year bonds. Generally, the cost of debt is higher for bonds with longer time to maturity. It has to do with risk. The longer

Reinvestment Returns: I found "b" (the reinvestment rate) by using exhibit 1 to calculate the percentage of net income per share of common stock that is paid out in dividends, and subtracting it from 1 to solve for the percentage reinvested. The return on equity, "k", is found by dividing net income (exhibit 1) by book value (exhibit 2). G = b*k shows g = 8.14%.

{. How many consecutives years the company has been profitable, its current ration and its ROE

The tax rate is estimated from case Exhibit 2 as Income Taxes ($496 million) divided by Earnings Before Taxes, Non-controlling Interest and Goodwill Amortization ($990 million). Note that, in 2001, interest on the company’s total debt is approximately 3.8%: $317 million of interest / $8,361 million of debt. However, this calculation is misleading since the 2000 debt is much larger than the 1999 debt of $2,270 (not in the case). You should ask yourself…should you use current yields or historical yields when calculating the cost of debt? Current yield figures should be used because Telus is considering

Dividends were assumed to grow at the geometric average of the last 6 years, 20.28%. P0 = D2 Dn Pn D1 + + ··· + + 1 2 n (1 + Ke ) (1 + Ke ) (1 + Ke ) (1 + Ke )n $1.58 $2.28 $87.31 $1.31 + + ··· + + = 1 2 4 (1 + 7.0%) (1 + 7.0%) (1 + 7.0%) (1 + 7.0%)4 = $72.53

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).

DebtThe first component of a firms WACC is its cost of debt. This is the effective rate that a company pays on its current debt. Because interest expenses on debt are deductible, the after-tax cost is used in its calculation. Cost of debt is calculated by multiplying the before-tax rate by one minus the marginal tax rate. As given in the Silicon Valley case assignment handout, SIVMED's long-term debt consists of 9.5% coupon, semiannual payment bonds with 15 years to maturity. The bonds last traded at a price of $891.00 per $1,000 par value bond. Given this data, SIVMED's cost of debt is calculated at 6.6% .

Thus the WAVG Cost of Debt (including L/T debt and preferred stock) = rd = 8.633%

For your job as the business reporter for a local newspaper, you are asked to put together a series of articles on multinational finance and the international currency markets for your readers. Much recent local press coverage has been given to losses in the foreign exchange markets by JGAR, a local firm that is the subsidiary of Daedlufetarg, a large German manufacturing firm.