Question 14 Your company has compiled the following data which is based on current costs relative to its sources of external capital ie long-term debt, preferred stock and common stock equity for various ranges of financing. Source of Capital After-tax Cost Range of Total New Financing 0 to Long-term debt 4 % 1697594 8 1697595 to 3259148 12 3259149 to above Preferred stock 17 0 to 936034 22 936035 to above Common stock equity 18 0 to 1141333 21 1141334 to 2808705 25 2808705 to 3549127 26 3549127 to above Current retained earnings in coming year Cost of retained earnings based on current earnings 628988 18 % The target capital structure proportions are: Target capital structure Long-term debt 32 % Preferred stock 11 % Equity 57 %

Question 14 Your company has compiled the following data which is based on current costs relative to its sources of external capital ie long-term debt, preferred stock and common stock equity for various ranges of financing. Source of Capital After-tax Cost Range of Total New Financing 0 to Long-term debt 4 % 1697594 8 1697595 to 3259148 12 3259149 to above Preferred stock 17 0 to 936034 22 936035 to above Common stock equity 18 0 to 1141333 21 1141334 to 2808705 25 2808705 to 3549127 26 3549127 to above Current retained earnings in coming year Cost of retained earnings based on current earnings 628988 18 % The target capital structure proportions are: Target capital structure Long-term debt 32 % Preferred stock 11 % Equity 57 %

Fundamentals of Financial Management, Concise Edition (with Thomson ONE - Business School Edition, 1 term (6 months) Printed Access Card) (MindTap Course List)

8th Edition

ISBN:9781285065137

Author:Eugene F. Brigham, Joel F. Houston

Publisher:Eugene F. Brigham, Joel F. Houston

Chapter13: Capital Structure And Leverage

Section: Chapter Questions

Problem 14SP: WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital...

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WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm dots not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasure staff consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firms debt cost at different debt levels: Elliott uses the CAPM to estimate its cost of common equity, rd and estimates that the risk free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its unlevered beta, but would be 1.2. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure? d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1) e. the debt/capital ratio and (2) the debt /equity ratio.
WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm dots not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasure staff consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firms debt cost at different debt levels: Elliott uses the CAPM to estimate its cost of common equity, rd and estimates that the risk free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its unlevered beta, but would be 1.2. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure? d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1) e. the debt/capital ratio and (2) the debt /equity ratio.
WACC AND OPTIMAL CAPITAL STRUCTURE Elliott Athletics is trying to determine its optimal capital structure, which now consists of only debt and common equity. The firm does not currently use preferred stock in its capital structure, and it does not plan to do so in the future. Its treasury staff has consulted with investment bankers. On the basis of those discussions, the staff has created the following table showing the firm's debt cost at different debt levels: Elliott uses the CAPM to estimate its cost of common equity, rs, and estimates that the risk-free rate is 5%, the market risk premium is 6%, and its tax rate is 40%. Elliott estimates that if it had no debt, its unlevered beta, bU, would be 1.2. a. What is the firm's optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliott's managers anticipate that the company's business risk will increase in the future, what effect would this likely have on the firm's target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliott's target capital structure? d. Plot a graph of the after-tax cost of debt, the cost of equity, and the WACC versus (1) the debt/capital ratio and (2) the debt/equity ratio.
CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 3. Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it. One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the companys home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firms WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?
Begin with the partial model in the file Ch02 P21 Build a Model.xlsx on the textbooks Web site. a. Using the financial statements shown here for Lan Chen Technologies, calculate net operating working capital, total net operating capital, net operating profit after taxes, free cash flow, and return on invested capital for 2020. The federal-plus-state tax rate is 25%. b. Assume there were 15 million shares outstanding at the end of 2019, the year-end closing stock price was 65 per share, and the after-tax cost of capital was 10%. Calculate EVA and MVA for 2020. Lan Chen Technologies: Income Statements for Year Ending December 31 (Millions of Dollars) Lan Chen Technologies: December 31 Balance Sheets (Thousands of Dollars)
CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 1. As a first step, we need to estimate what percentage of MMMs capital comes from debt, preferred stock, and common equity. This information can be found on the firms latest annual balance sheet. (As of year end 2013, MMM had no preferred stock.) Total debt includes all interest-bearing debt and is the sum of short-term debt and long-term debt. a. Recall that the weights used in the WACC are based on the companys target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its balance sheet, what weights should you use to estimate the WACC for MMM? b. Find MMMs market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the balance sheet (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firms debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.
Problem 21-05 Given the following, determine the firm’s optimal capital structure: Debt/Assets After-Tax Cost of Debt Cost of Equity 0 % 7 % 11 % 10 7 11 20 7 11 30 8 12 40 9 14 50 10 15 60 13 16 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 20 percent debt and 80 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 20% 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.…
QUESTION 4 Madiba Ltd’s optimal capital structure calls for 35% debt and 65% equity. The after-tax cost of debt is 12%; its cost of ordinary shares funding from retained earnings is 14%; and its marginal tax rate is 28%. Madiba Ltd’s has the following investment opportunities: Supersonic: Cost = R 50 000; IRR = 11.90%. Telefunken: Cost = R100 000; IRR = 13.00% LG: Cost = R150 000; IRR = 14.50%. Sony: Cost = R200 000; IRR =15.70%. Madiba expects to have a net income of R250 000 and bases its dividend payment on the residual policy. How much would Madiba Ltd’s pay in dividends (after accepting all profitable projects) if it were to follows the residual theory of dividends?
Problem A A firm has determined its cost of each source of capital and optimal capital structure, which is composed of the following sources and target market value proportions: Target market Source of capital proportion After‑tax cost of capital ______________________________________________________ Long‑term debt 40% 6% Preferred stock 10% 11% Common stock equity 50% 15% What is the weighted average cost of capital (WACC)?
Assume the following data for U&P Company: Debt (D) = $100 million; Equity (E) = $300 million; rD = 6%; rE = 12%; and TC = 30%. Calculate the after-tax weighted average cost of capital (WACC): Multiple Choice A) 10.5% B) 10.05% C) 15% D) 9.45%
Can you explain the information below market value added (MVA) analysis and interpretation of results below. Market Value of Equity:$133,341,000,000.00 Plus: Market Value of Debt:$13,677,000.00 Equals: Market Value of Firm:$133,354,677,000.00 Minus: Total Invested Capital:($1,944,100.00) Equals: MVA$133,356,621,100.00
Problem 1 - Cost of Capital Bob-Bye, Inc. has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The WACC is to be measured by using the following weights:: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained earnings, new common stock, or both). The firm’s tax is 30%. Debt: The firm can sell for P980, a 10-year, P1,000 par value bond paying annual interest at a 13% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of P20 per bond. Preferred Stock: 8 percent (annual divided) preferred stock having a par value of P100 can be sold for P65. An additional fee of P2 per share must be paid to the underwriters. Common Stock: The firm’s common stock is currently selling for P50 per share. The dividend expected to be paid at the end of the coming year is P4 per share.. Its dividend payments which have been approximately 60% of earnings per share…