During the few previous years, Company J has been controlled with the aid of high price of capital to make investments. Recently, it is observed that, capital costs have been deteriorating and firm has decided to notice severely at a primary expansion program suggested by marketing and advertising department. For this purpose, the major task for the company is to estimate its cost of capital. To determine: Division’s cost of capital.

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Imagine you are the manager of operations for a manufacturing company. Your vice president wants to expand production by building a new facility, and she would like you to develop a business case for the project. Assume that your company’s weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is 10.5%, and common equity is 15%. As you work on the business case, you surmise that this is a fairly risky project because of a recent slowing in product sales. In fact, when using the 13% weighted average cost of capital, you discover that the project is estimated to return about 10%, which is quite a bit less than the company’s weighted average cost of capital. Your vice president suggests that the project could be financed from a mix of retained earnings (50%) and bonds (50%). She reasons that retained earnings do not cost the company anything because it is cash you already have and the after-tax cost of debt is only 7%. That would lower your weighted…

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Chapter 11, Problem 12MC

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Case summary:

During the few previous years, Company J has been controlled with the aid of high price of capital to make investments. Recently, it is observed that, capital costs have been deteriorating and firm has decided to notice severely at a primary expansion program suggested by marketing and advertising department. For this purpose, the major task for the company is to estimate its cost of capital.

To determine: Division’s cost of capital.

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Imagine you are the manager of operations for a manufacturing company. Your vice president wants to expand production by building a new facility, and she would like you to develop a business case for the project. Assume that your company’s weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is 10.5%, and common equity is 15%. As you work on the business case, you surmise that this is a fairly risky project because of a recent slowing in product sales. In fact, when using the 13% weighted average cost of capital, you discover that the project is estimated to return about 10%, which is quite a bit less than the company’s weighted average cost of capital. Your vice president suggests that the project could be financed from a mix of retained earnings (50%) and bonds (50%). She reasons that retained earnings do not cost the company anything because it is cash you already have and the after-tax cost of debt is only 7%. That would lower your weighted…

Suppose your firm has decided to use a divisional WACC approach to analyze projects. The firm currently has four divisions, A through D, with average betas for each division of 0.9, 1.3, 1.4, and 1.5, respectively. Assume all current and future projects will be financed with 35 percent debt and 65 percent equity, the current cost of equity (based on an average firm beta of 1.3 and a current risk-free rate of 4 percent) is 15 percent and the after-tax yield on the company’s bonds is 9 percent. What will the WACCs be for each division? Note: Do not round intermediate calculations. Round your final answers to 2 decimal places.