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- Given the following, determine the firm’s optimal capital structure:
Debt/Assets After-Tax Cost of Debt Cost of Equity 0 % 6 % 10 % 10 6 10 20 6 10 30 8 11 40 8 12 50 10 12 60 12 14 Round your answers for capital structure to the nearest whole number and for the cost of capital to one decimal place.
The optimal capital structure: % debt and % equity with a cost of capital of %
- If the firm were using 50 percent debt and 50 percent equity, what would that tell you about the firm’s use of financial leverage? Round your answer for the cost of capital to one decimal place.
If the firm uses 50% debt financing, it would be using financial leverage. At that combination the cost of capital is %. The firm could lower the cost of capital by substituting .
- What two reasons explain why debt is cheaper than equity?
Debt is cheaper than equity because interest expense . In addition, equity investors bear risk.
- If the firm were using 20 percent debt and 80 percent equity and earned a return of 8.4 percent on an investment, would this mean that stockholders would receive less than their required return of 10.0 percent?
If the firm earns 8.4% on an investment, the stockholders will earn than their required 10.0%.
What return would stockholders receive? Round your answer to one decimal place.
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- COST OF CAPITAL Coleman Technologies is considering a major expansion program that has been proposed by the companys information technology group. Before proceeding with the expansion, the company must estimate its cost of capital. Suppose you are an assistant to Jerry Lehman, the financial vice president. Your first task is to estimate Colemans cost of capital Lehman has provided you with the following data, which he believes may be relevant to your task. The firms tax rate is 25%. The current price of Colemans 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity, is 1.153.72. Coleman does not use short-term, interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firms 10%, 100.00 par value, quarterly dividend, perpetual preferred stock is 111.10. Colemans common stock is currently selling for 50.00 per share. Its last dividend (D0) was 4.19, and dividends are expected to grow at a constant annual rate of 5% in the foreseeable future. Colemans beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4%. Colemans target capital structure is 30% debt, 10% preferred stock, and 60% common equity. To structure the task somewhat, Lehman has asked you to answer the following questions: a. 1. What sources of capital should be included when you estimate Colemans WACC? 2. Should the component costs be figured on a before-tax or an a after-tax basis? 3. Should the costs be historical (embedded) costs or new (marginal) costs? b. What is the market interest rate on Colemans debt and its component cost of debt? c. 1. What is the firms cost of preferred stock? 2. Colemans preferred stock is riskier to investors than its debt, yet the preferreds yield to investors is lower than the yield to maturity on the debt Does this suggest that you have made a mistake? (Hint: Think about taxes) d. 1. Why is there a cost associated with retained earnings? 2. What is Colemans estimated cost of common equity using the CAPM approach? e. What is the estimated cost of common equity using the DCF approach? f. What is the bond-yield-plus-risk-premium estimate for Colemans cost of common equity? g. What is your final estimate for rs? h. Explain in words why new common stock has a higher cost than retained earnings. i. 1. What are two approaches that can be used to adjust for flotation costs? 2. Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost? j. What is Colemans overall, or weighted average, cost of capital (WACC)? Ignore flotation costs. k. What factors influence Colemans composite WACC? l. Should the company use the composite WACC as the hurdle rate for each of its projects? Explain.Given the following, determine the firm’s optimal capital structure: Debt/Assets After-Tax Cost of Debt Cost of Equity 0 % 6 % 11 % 10 7 11 20 7 12 30 7 13 40 9 13 50 10 13 60 13 14 Round your answers for capital structure to the nearest whole number and for the cost of capital to one decimal place. The optimal capital structure: % debt and % equity with a cost of capital of % If the firm were using 60 percent debt and 40 percent equity, what would that tell you about the firm’s use of financial leverage? Round your answer for the cost of capital to one decimal place. If the firm uses 60% debt financing, it would be using financial leverage. At that combination the cost of capital is %. The firm could lower the cost of capital by substituting . What two reasons explain why debt is cheaper than equity? Debt is cheaper than equity because interest expense . In addition, equity investors bear risk. If the firm were…WACC and target weights After careful analysis, Dexter Brothers has determined that its optimal capital structure is composed of the sources and target market value weights shown in the following table. Source of capital Target market value weight Long-term debt 30% Preferred stock 15 Common stock equity 55 Total 100% The cost of debt is 4.2%, the cost of preferred stock is 9.5%, the cost of retained earnings is 13.0%, and the cost of new common stock is 15.0%. All are after-tax rates. The company's debt represents 25%, the preferred stock represents 10%, and the common stock equity represents 65% of total capital on the basis of the current market values of the three components. The company expects to have a significant amount of retained earnings available and does not expect to sell any new common stock. Calculate the WACC on the basis of historical market value weights. Calculate the WACC on the basis of target market value weights. Compare the answers obtained in parts a and b.…
- The calculation of WACC involves calculating the weighted average of the required rates of return on debt, preferred stock, and common equity, where the weights equal the percentage of each type of financing in the firm’s overall capital structure. is the symbol that represents the before-tax cost of debt in the weighted average cost of capital (WACC) equation. Wyle Co. has $1.4 million of debt, $2.5 million of preferred stock, and $3.3 million of common equity. What would be its weight on debt? 0.28 0.32 0.19 0.46The L Corp. has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Calculate the firm’s weighted average cost of capital (WACC). Assume external equity for cost of equity calculation. rd before Tax = 8% , Tax = 40% , P0 = $40, Growth = 6% , D0 = $3.00, Flotation cost = 7% of market price 10.64% 13.05% 7.24% 8.61% 9.83%You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt.The cost of debt capital is 8 percent , while the cost of equity capital is 20 percent for the firm . What is the Coverall cost of capital for the firm ? Select one a . None of these b . 12.2 % C. 15.8 % d . 20.2 %
- A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm’s weighted average cost of capital (WACC). Assume external equity for cost of equity calculation. rd before Tax = 8% , Tax = 40% , P0 = $40, Growth = 6% , D0 = $3.00, Flotation cost = 7% of market priceYou are analyzing the cost of capital for a firm that is financed with 60 percent equity and 50 percent debt . The cost of debt capital is 8 percent , while the cost of equity capital is 20 percent for the firm What is the overall cost of capital for the firm ? Select one A. 15.2 % B. None of these C. 20.2 % D.14.2 %if A firm's current balance sheet is as follows: Assets $100 Debt $10 Equity $90 a. what is the firm's weighted-average cost of capital at various combinations of debt and equity, given the following information? Debt/assets after-tax cost of Debt cost of equity cost of capital 0% 8% 12% ? 10 8 12 ? 20 8 12 ? 30 8 13 ? 40 9 14 ? 50 10…
- You are analyzing the cost of capital for a firm that is financed with 65 percent equity and 35 percent debt.The cost of debt capital is 8 percent, while the cost of equity capital is 20 percent for the firm. What is the overall cost of capital for the firm? Select one: a. 20.2 % b. 15.8 % c. 12.2 % d. None of theseThe basic WACC equation The calculation of a weighted average cost of capital (WACC) involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the percentage of each type of financing in the firm’s overall capital structure. what is the symbol that represents the cost of preferred stock in the weighted average cost of capital (WACC) equation.__________ Bob Co. has $1.26 million of debt, $3.16 million of preferred stock, and $2.02 million of common equity. The appropriate weight of the firm's preferred stock in the calculation of the company's weighted average cost of capital is____________% .A firm’s current balance sheet is as follows: Assets $ 110 Debt $ 44 Equity $ 66 What is the firm’s weighted-average cost of capital at various combinations of debt and equity, given the following information? Round your answers to one decimal place. Debt/Assets After-Tax Cost of Debt Cost of Equity Cost of Capital 0 % 6 % 13 % % 10 6 13 % 20 6 13 % 30 7 14 % 40 8 15 % 50 9 16 % 60 11 17 % Construct a pro forma balance sheet that indicates the firm’s optimal capital structure. Choose the best structure from the options analyzed in part a. Compare this balance sheet with the firm’s current balance sheet. Round your answers to the nearest dollar. Assets $ 110 Debt $ Equity $ What course of action should the firm take? Round your answer to the nearest whole number. Since the firm is currently using % debt financing, it at its optimal capital structure and As a…
