Concept explainers
a.
To calculate: The cost of debt for Northwest Utility Company.
Introduction:
Cost of debt (Kd):
It refers to the effective interest rate paid by the company on its debt such as bonds and loans. Such interest payments are tax deductible.
b.
To calculate: The cost of
Introduction:
Cost of preferred stock(KP):
It refers to the dividend amount paid annually by the company on its preferred stock. Such
dividends are not tax deductible and can be calculated by dividing the annual preferred
dividend by the current market price of the preferred stock.
c.
To calculate: The
Introduction:
Retained Earnings:
These are considered as the profits of the company and are not distributed as dividends to the shareholders. These are reserved for the purpose of reinvesting into the business, that is, for the expansion of the business.
d.
To calculate: The WACC for Northwest Utility Company.
Introduction:
Weighted average cost of capital (WACC):
It is defined as the rate at which a company needs to pay on average to all its shareholders in
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FOUND.OF FINANCIAL MANAGEMENT-ACCESS
- Northwest Utility Company faces Increasing needs for capital. Fortunately. It has an Aa3 credit rating. The corporate tax rate is 30 percent. Northwest's treasurer is trying to determine the corporation's current weighted average cost of capital in order to assess the profitability of capital budgeting projects. Historically, the corporation's earnings and dividends per share have Increased about 9.6 percent annually and this should continue in the future. Northwest's common stock is selling at $71 per share, and the company will pay a $8.20 per share dividend (D₁); The company's $110 preferred stock has been yielding 8 percent in the current market. Flotation costs for the company have been estimated by its investment banker to be $6.00 for preferred stock. The company's optimum capital structure is 50 percent debt, 25 percent preferred stock, and 25 percent common equity in the form of retained earnings. Refer to the following table on bond Issues for comparative yields on bonds of…arrow_forwardKielly Machines Inc. is planning an expansion program estimated to cost $100 million. Kielly is going to raise funds according to its target capital structure shown below. Debt 0.30 Preferred stock 0.24 Equity 0.46 Kielly had net income available to common shareholders of $184 million last year of which 75% was paid out in dividends. The company has a marginal tax rate of 40%. Additional data: The before-tax cost of debt is estimated to be 11%. The market yield of preferred stock is estimated to be 12%. The after-tax cost of common stock is estimated to be 16% What is Kielly's weighted average cost of capital? Select one: a. 14.00% b. 12.22% c. 13.54% d. 13.00%arrow_forwardKendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $15 million to fund all of its positive-NPV projects, and her job is to determine how to raise the money. Reynolds’s net income is $11 million , and it has paid a $2.00 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. d. Can Reynolds maintain its current capital structure, maintain its current dividend per share, and maintain a $15 million capital budget without having to raise new common stock? e. Suppose Reynolds’s management is firmly opposed to cutting the dividend; that is, it wishes to maintain the $2.00 dividend for the next year. Suppose also that the company is committed to funding all profitable projects and is willing to issue more debt (along…arrow_forward
- Kendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $15 million to fund all of its positive-NPV projects, and her job is to determine how to raise the money. Reynolds’s net income is $11 million , and it has paid a $2.00 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. a. Suppose Reynolds follows the residual model and makes all distributions as dividends. How much retained earnings will it need to fund its capital budget? b. If Reynolds follows the residual model with all distributions in the form of dividends, what will be its dividend per share and payout ratio for the upcoming year? c. If Reynolds maintains its current $2.00 DPS for next year, how much retained earnings will be available for the…arrow_forwardKendra Brown is analyzing the capital requirements for Reynolds Corporation for next year. Kendra forecasts that Reynolds will need $15 million to fund all of its positive-NPV projects, and her job is to determine how to raise the money. Reynolds’s net income is $11 million , and it has paid a $2.00 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. a. Suppose Reynolds follows the residual model and makes all distributions as dividends. How much retained earnings will it need to fund its capital budget? b. If Reynolds follows the residual model with all distributions in the form of dividends, what will be its dividend per share and payout ratio for the upcoming year? g. Now consider the case in which Reynolds’s management wants to maintain the $2.00 DPS and its target capital structure…arrow_forwardAnnamz Corp. is looking at two possible capital structures. Currently, the firm is an all-equity firm with $1.2 million dollars in assets and 200,000 shares outstanding. The market value of each stock is $6.00. The CEO of Annamz is thinking of leveraging the firm by selling $600,000 of debt financing. The cost of debt is 8% annually, and the current corporate tax rate for Annamz is 30%. What is the break-even EBIT for Annamz with these two possible capital structures?arrow_forward
- Flagstaff Enterprises expected to have free cash flow in the coming year of $8 million, and this free cash flow is expected to grow at a rate of 3% per year thereafter. Flagstaff has an equity cost of capital of 13%, a debt cost of capital of 7%, and it is in the 35% corporate tax bracket. Flagstaff maintains a constant debt-to-equity ratio of 0.5. Assume that capital markets are perfect except for the existence of corporate taxes. a)What is Flagstaff's after-tax WACC? b)What is the value of Flagstaff as a levered firm? c)What is the value of Flagstaff's interest tax shield? d)Briefly discuss the trade-off theory. What is the optimal capital structure according to the trade-off theory?arrow_forwardSuppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. H. If a firm follows the residual distribution policy, what actions can it take when its forecasted retained earnings are less than the retained earnings required to fund its capital budget? I. Define the term ‘Dividend Policy’? What are the main elements of the Dividend Policy? J. What are the different theories on investor preference for dividends? Explain each theory?arrow_forwardSuppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. F. Suppose once again that management wants to maintain the $2 DPS. In addition, the company wants to maintain its target capital structure (30% debt, 70% equity) and its $15 million capital budget. What is the minimum dollar amount of new common stock the company would have to issue in order to meet all of its objectives? G. Now consider the case in which management wants to maintain the $2 DPS and its target capital structure but…arrow_forward
- Suppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. D. Can the company maintain its current capital structure, maintain its current dividend per share, and maintain a $15 million capital budget without having to raise new common stock? Why or why not? E. Suppose management is firmly opposed to cutting the dividend; that is, it wishes to maintain the $2 dividend for the next year. Suppose also that the company is committed to funding all profitable projects and is willing to issue more…arrow_forwardSuppose that you are analysing the capital requirements for your Corporation for next year. You forecast that the company will need $15 million to fund all of its positive-NPV projects and you job is to determine how to raise the money. The corporation’s net income is $11 million, and it has paid a $2 dividend per share (DPS) for the past several years (1 million shares of common stock are outstanding); its shareholders expect the dividend to remain constant for the next several years. The company’s target capital structure is 30% debt and 70% equity. Questions: A. Suppose the firm follows the residual model and makes all distributions as dividends. How much retained earnings will it need to fund its capital budget? B. If the company follows the residual model with all distributions in the form of dividends, what will be its dividend per share and pay-out ratio for the upcoming year? C. If the company maintains its current $2 DPS for next year, how much retained earnings will be…arrow_forwardes Edsel Research Labs has $26.40 million in assets. Currently half of these assets are financed with long-term debt at 6 percent and ha with common stock having a par value of $10. Ms. Edsel, the Vice President of Finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The company earns a return on assets before interest and taxes of 8 percent. The tax rate is 30 percent. Under Plan D, a $6.60 million long-term bond would be sold at an interest rate of 8 percent and 660,000 shares of stock would be purchased in the market at $10 per share and retired. Under Plan E, 660,000 shares of stock would be sold at $10 per share and the $6,600,000 in proceeds would be used to reduce long-term debt. a-1. Compute earnings per share considering the current plan and the two new plans. Note: Round your answers to 2 decimal places. Current Plan D Plan E Earnings per Share $ $ $ 0.42 0.20 1.26 a-2. Which plan(s) would produce the highest EPS? Note that…arrow_forward
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