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- 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 2014, 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.A company had WACC (weighted average cost of capital) equal to 8. % If the company pays off mortgage bonds with an interest rate of 4% and issues an equal amount of new stock considered to be relatively risky by the market, which of the following is true? a. residual income will increase. b. ROI will decrease. c. WACC will increase. d. WACC will decrease.Biotec has estimated the costs of debt and equity capital for various proportions of debt in its capital structure: % of Debt Cost of Debt (%) Cost of Equity (%) 35 5.4 13.8 40 5.6 14.0 45 5.9 14.3 50 6.4 14.7 If Biotec pays a current dividend of $1.00 and expects dividends to grow at a constant rate of 7%, what is Biotec's stock price if it obtains its optimal capital structure?
- Burnham Brothers Inc. has no retained earnings since it has always paid out all of its earnings as dividends. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? The market risk premium declines. The flotation costs associated with issuing new common stock increase. The company's beta increases. Expected inflation increases. The flotation costs associated with issuing preferred stock increase.You have the following information on a company on which to base your calculations and discussion: Cost of equity capital (rE) = 18.55% Cost of debt (rD) = 7.85% Expected market premium (rM –rF) = 8.35% Risk-free rate (rF) = 5.95% Inflation = 0% Corporate tax rate (TC) = 35% Current long-term and target debt-equity ratio (D:E) = 2:5 a. What are the equity beta (bE) and debt beta (bD) of the firm described above?[Hint: Assume that the above costs of capital have been generated by an appropriate equilibrium model.] b. What is the weighted-average cost of capital (WACC) for this firm at the current debt-equity ratio? c. What would the company’s cost of equity capital become if you unlevered the capital structure (i.e. reduced gearing until there is no debt)Schalheim Sisters Inc. has always paid out all of its earnings as dividends; hence, the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? A. The flotation costs associated with issuing preferred stock increase. B. The company's beta increases. C. The flotation costs associated with issuing new common stock increase. D. The market risk premium declines. E. Expected inflation increases.
- When using the capital asset pricing model to estimate the cost of equity for a firm being valued, beta is often adjusted to account for: Debt ratios of comparable firms that are leveraged differently from that of the firm being valued. The level of cash held at comparable firms. The number of common stock shares outstanding at comparable firms. The default rate of corporate bonds over the last year. All of the above.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. (rs, rd, rp, re) is the symbol that represents the cost of raising capital by issuing new stock in the weighted average cost of capital (WACC) equation. Avery Co. has $2.7 million of debt, $1.5 million of preferred stock, and $2.2 million of common equity. What would be its weight on preferred stock? 0.23 0.21 0.42 0.18Under normal circumstances, the weighted average cost of capital is used as the firm's required rate of return because a. as long as the firm's investments earn returns greater than the cost of capital, the value of the firm will increase b. it is comparable to the average of all the interest rates on debt that currently prevail in the financial markets c. returns below the cost of capital will cover all the fixed costs associated with capital and provide excess returns to the firm's stockholders
- Which statement is false regarding the Capital Asset Pricing Model? A. The beta coefficient of a stock is constant. B. The risk free rate is usually based on the treasury bill yield. C. Market risk premium is the difference between market return and the risk free rate. D. The cost of retained earnings is equal to the cost of new shares issued.According to the following information, what is the firm's optimal capital structure? Proportion Earnings Per Weighted Average Cost of Debt Share (EPS) of Capital (WACC) 30% $2.50 13.2% 40 3.80 12.7 50 4.75 12.4 60 5.25 12.8 To determine the optimal capital structure, the market value of the stock must be known.Is the debt level that maximizes a firm's expected EPS the same as the one that maximizes its stock price? Explain. Explain how a firm might shift its capital structure so as to change its weighted average cost of capital (WACC). What would be the impact on the value of the firm?
