Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars): 2021 Current assets $ 2,000 Net fixed assets 3,000 Total assets $ 5,000 Accounts payable and accruals $ 900 Short-term debt 200 Long-term debt 1,200 Preferred stock (10,000 shares) 300 Common stock (40,000 shares) 1,175 Retained earnings 1,225 Total common equity $ 2,400 Total liabilities and equity $ 5,000 Skye's earnings per share last year were $3.75. The common stock sells for $65.00, last year's dividend (D0) was $2.75, and a flotation cost of 9% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 8%. Skye's preferred stock pays a dividend of $3.85 per share, and its preferred stock sells for $35.00 per share. The firm's before-tax cost of debt is 11%, and its marginal tax rate is 25%. The firm's currently outstanding 11% annual coupon rate, long-term debt sells at par value. The market risk premium is 5%, the risk-free rate is 6%, and Skye's beta is 1.476. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.4 million. The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimal places. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity. After-tax cost of debt: Cost of preferred stock: Cost of retained earnings: Cost of new common stock: Now calculate the cost of common equity from retained earnings, using the CAPM method. fill in the blank What is the cost of new common stock based on the CAPM? (Hint: Find the difference between re and rs as determined by the DCF method, and add that differential to the CAPM value for rs.) fill in the blank If Skye continues to use the same market-value capital structure, what is the firm's WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so rapidly that it must issue new common stock? (Hint: Use the market value capital structure excluding current liabilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC.) WACC1: WACC2:

Managerial Accounting
15th Edition
ISBN:9781337912020
Author:Carl Warren, Ph.d. Cma William B. Tayler
Publisher:Carl Warren, Ph.d. Cma William B. Tayler
Chapter16: Financial Statement Analysis
Section: Chapter Questions
Problem 21E
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Here is the condensed 2021 balance sheet for Skye Computer Company (in thousands of dollars):

 

  2021
Current assets   $ 2,000  
Net fixed assets     3,000  
Total assets   $ 5,000  
 
Accounts payable and accruals   $ 900  
Short-term debt     200  
Long-term debt     1,200  
Preferred stock (10,000 shares)     300  
Common stock (40,000 shares)     1,175  
Retained earnings     1,225  
  Total common equity   $ 2,400  
Total liabilities and equity   $ 5,000  

 

Skye's earnings per share last year were $3.75. The common stock sells for $65.00, last year's dividend (D0) was $2.75, and a flotation cost of 9% would be required to sell new common stock. Security analysts are projecting that the common dividend will grow at an annual rate of 8%. Skye's preferred stock pays a dividend of $3.85 per share, and its preferred stock sells for $35.00 per share. The firm's before-tax cost of debt is 11%, and its marginal tax rate is 25%. The firm's currently outstanding 11% annual coupon rate, long-term debt sells at par value. The market risk premium is 5%, the risk-free rate is 6%, and Skye's beta is 1.476. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1.4 million.

The data has been collected in the Microsoft Excel file below. Download the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations. Round your answers to two decimal places.

 

  1. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock, the cost of equity from retained earnings, and the cost of newly issued common stock. Use the DCF method to find the cost of common equity.

    After-tax cost of debt: 

    Cost of preferred stock: 

    Cost of retained earnings: 

    Cost of new common stock: 

  2. Now calculate the cost of common equity from retained earnings, using the CAPM method.

    fill in the blank 

  3. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between re and rs as determined by the DCF method, and add that differential to the CAPM value for rs.)

    fill in the blank 

  4. If Skye continues to use the same market-value capital structure, what is the firm's WACC assuming that (1) it uses only retained earnings for equity and (2) if it expands so rapidly that it must issue new common stock? (Hint: Use the market value capital structure excluding current liabilities to determine the weights. Also, use the simple average of the required values obtained under the two methods in calculating WACC.)

    WACC1

    WACC2

Calculating the WACC
Skye Computer Company: Balance Sheet as of December 31
(in thousands of dollars)
Current assets
Net fixed assets
Total assets
Accounts payable and accruals
Short-term debt
Long-term debt
Preferred stock
Common stock
Retained earnings
Total common equity
Total liabilities and equity
Last year's earnings per share
Current price of common stock, Po
Last year's dividend on common stock, Do
Growth rate of common dividend, g
Flotation cost for common stock, F
Common stock outstanding
Current price of preferred stock, Pp
Dividend on preferred stock, Dp
Preferred stock outstanding
Before-tax cost of debt, ra
Market risk premium, ™M - RF
Risk-free rate, RF
Beta
Tax rate
Total debt
2021
$2,000
3,000
$5,000
$900
200
1,200
300
1,175
1,225
$2,400
$5,000
$3.75
$65.00
$2.75
8%
9%
40,000
$35.00
$3.85
10,000
11%
5%
6%
1.476
25%
$1,400 t
Transcribed Image Text:Calculating the WACC Skye Computer Company: Balance Sheet as of December 31 (in thousands of dollars) Current assets Net fixed assets Total assets Accounts payable and accruals Short-term debt Long-term debt Preferred stock Common stock Retained earnings Total common equity Total liabilities and equity Last year's earnings per share Current price of common stock, Po Last year's dividend on common stock, Do Growth rate of common dividend, g Flotation cost for common stock, F Common stock outstanding Current price of preferred stock, Pp Dividend on preferred stock, Dp Preferred stock outstanding Before-tax cost of debt, ra Market risk premium, ™M - RF Risk-free rate, RF Beta Tax rate Total debt 2021 $2,000 3,000 $5,000 $900 200 1,200 300 1,175 1,225 $2,400 $5,000 $3.75 $65.00 $2.75 8% 9% 40,000 $35.00 $3.85 10,000 11% 5% 6% 1.476 25% $1,400 t
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