Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%. Component Scenario 1 Scenario 2 Cost of Capital Tax Rate Debt $5,000,000.00 $2,000,000.00 8% 30% Preferred Stock 1,200,000.00 2,200,000.00 10% Common Stock 1,800,000.00 3,800,000.00 13% Total $8,000,000.00 $8,000,000.00 1-a. Complete the table below to determine the WACC for each of the two capital structure scenarios. (Enter your answer as a whole percentage rounded to 2 decimal places (e.g. .3555 should be entered as 35.55).) 1-b. Which capital structure shall Mr. Johnson choose to fund the new project? Scenario 1 Scenario 2
Cost of Debt, Cost of Preferred Stock
This article deals with the estimation of the value of capital and its components. we'll find out how to estimate the value of debt, the value of preferred shares , and therefore the cost of common shares . we will also determine the way to compute the load of every cost of the capital component then they're going to estimate the general cost of capital. The cost of capital refers to the return rate that an organization gives to its investors. If an organization doesn’t provide enough return, economic process will decrease the costs of their stock and bonds to revive the balance. A firm’s long-run and short-run financial decisions are linked to every other by the assistance of the firm’s cost of capital.
Cost of Common Stock
Common stock is a type of security/instrument issued to Equity shareholders of the Company. These are commonly known as equity shares in India. It is also called ‘Common equity
Part 1
Peter Johnson, the CFO of Homer Industries, Inc is trying to determine the Weighted Cost of Capital (WACC) based on two different capital structures under consideration to fund a new project. Assume the company’s tax rate is 30%.
| Component | Scenario 1 | Scenario 2 | Cost of Capital | Tax Rate |
|---|---|---|---|---|
| Debt | $5,000,000.00 | $2,000,000.00 | 8% | 30% |
| 1,200,000.00 | 2,200,000.00 | 10% | ||
| Common Stock | 1,800,000.00 | 3,800,000.00 | 13% | |
| Total | $8,000,000.00 | $8,000,000.00 | ||
1-a. Complete the table below to determine the WACC for each of the two capital structure scenarios. (Enter your answer as a whole percentage rounded to 2 decimal places (e.g. .3555 should be entered as 35.55).)
1-b. Which capital structure shall Mr. Johnson choose to fund the new project?
-
Scenario 1
-
Scenario 2
Part 2
Assume the new project’s operating cash flows for the upcoming 5 years are as follows:
| Project A | |
|---|---|
| Initial Outlay | $ -8,000,000.00 |
| Inflow year 1 | 1,020,000.00 |
| Inflow year 2 | 1,850,000.00 |
| Inflow year 3 | 1,960,000.00 |
| Inflow year 4 | 2,370,000.00 |
| Inflow year 5 | 2,550,000.00 |
| WACC | ? |
2-a. What are the WACC (restated from Part 1), NPV,
2-b. Shall the company accept or reject this project based on the outcome using the
-
Project A should be accepted
-
Project A should be rejected
Trending now
This is a popular solution!
Step by step
Solved in 4 steps with 2 images
