CONTEMP.FINANCIAL MGMT. (LL)-W/MINDTAP
14th Edition
ISBN: 9780357292877
Author: MOYER
Publisher: CENGAGE L
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Question
Chapter 13, Problem 5P
a)
Summary Introduction
To determine: The optimal capital structure of firm in two scenarios.
b)
Summary Introduction
To determine: The difference between weighted cost of capital and optimal capital structure.
c)
Summary Introduction
To determine: The necessity of knowing the optimal capital structure
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Students have asked these similar questions
The financial manager of a firm determines the following schedules of cost of debt and cost of equity for various combinations of debt financing:
Debt/Assets
After-Tax Cost of Debt
Cost of Equity
0
%
4
%
7
%
10
4
7
20
4
7
30
4
9
40
5
10
50
5
12
60
8
13
70
8
15
Find the optimal capital structure (that is, optimal combination of debt and equity financing). Round your answers for the 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 %
Why does the cost of capital initially decline as the firm substitutes debt for equity financing?
The cost of capital initially declines because the firm cost of debt is than the cost of equity.
Why will the cost of funds eventually rise as the firm becomes more financially leveraged?
As the firm becomes more financially leveraged and riskier, the cost of debt…
The activity ratios measure which of the following?
Select one:
O a the efficiency of the company's supply chain
O b. the efficiency with which a company generates sales from its assets
Oc the profitability of the company's activities
Od the production efficiency of a company's fixed assets
If the assumption of financial distress costs is added, then Modigliani and Miller (with taxes) predicts that the optimal capital
structure is 100% debt
Select one:
O True
O False
Calculate the Weighted Average Cost of Capital (WACC) for McCormick and Company using the formula WACC = (WD x RD x (1-T)) + (WS x Rs)
Note that --
Rs = the cost of equity
Rd = the cost of debt
T = the tax rate
WD = Value of debt / (Value of debt plus value of equity)
WS = Value of equity / (Value of debt plus value of equity) **Note that the weight of debt plus the weight of equity must total to 100%, as there are only two components in the capital structure.**
In order to estimate the weights of debt and equity in the total capital structure, the CFO suggests using the book value of debt and the market value of equity. To determine the book value of debt, use data from the year end November 2019 McCormick 10-K. Look on the Balance sheet and add the following -- Short term borrowings, Current portion of long term debt, and Long term debt. To determine the market value of equity, use the following data: On March 17, 2020 the market value of equity (or "Market Cap")…
Chapter 13 Solutions
CONTEMP.FINANCIAL MGMT. (LL)-W/MINDTAP
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Similar questions
- Assume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: 09.86% 9.56% Percent Financed With Debt 10.16% 8.96% 9.26% 0.10 0.20 0.30 0.40 0.50 Percent Financed With Equity 0.90 0.80 0.70 0.60 0.50 Debt/Equity Ratio Now assume that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, Ks, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). 0.10/0.90 0.11 0.20/0.80 0.25 Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. 0.30/0.70=0.43 0.40/0.600.67 0.50/0.50 = 1.00 Bond Rating AA A A BB B Before-Tax Cost of Debt 7.0% 7.2%…arrow_forwarda) Calculate the weighted average cost of capital using following information: Total Cost of debt 4.40%. = 0.78 • Income tax rate Value of total debt = 16,595,600 OMR • Value of total debt = 6,595,325 OMR • Cost of equity %3D = 9.17% . b) Why weighted average cost of capital is important for capital structure decision making?arrow_forwardA firm's overall cost of capital is Select one :. A. Best measured by the cost of capital of the riskiest projects that the firm is working on B. a weighted average of the costs of capital for the collection of individual projects that the firm is working on C. equal to its cost debt d. None of thesearrow_forward
- Comment on each of the following statements:a) Equity cost of a company with debt is higher than that of a company without debt due to risk of bankruptcy.b) Only risks associated with corporate bonds are interest rate and reinvestment risk.c) In Modigliani-Miller model (from 1963) cost of capital depends positively on cost of debt.d) Weighted average cost of capital (WACC) can always be used to value projects or companies.e) All projects with positive NPV should be accepted and those with negative NPV should be rejected.f) Greater the growth opportunities, higher the level of indebtedness of companies.g) More tangible assets the firm has, the higher the level of indebtedness.arrow_forward1) In Modigliani & Miller (1963) model, cost of capital does not depend on cost of debt. Comment 2) Cost of equity of a company with debt is higher than that of a company without debt due to operational risk. Comment 3) Weighted average cost of capital (known as WACC) can always be used to value projects or companies. Commentarrow_forwardUsing the following information for Handy Hardware, determine the capital structure that results in the lowest weighted average cost of capital (WACC) for the firm. Explain your answer.arrow_forward
- In computing the cost of capital, the cost of debt capital is determined by Group of answer choices the capital asset pricing model. interest rate times (1 – the firm’s tax rate) annual interest payment divided by the book value of the debt. annual interest payment divided by the proceeds from debt issuance.arrow_forwardThe market values and after-tax costs of various sources of capital used by Ridge Tool are shown in the following table. Source of capital Market value Individual cost Long-term debt $700,000 5.3% Preferred stock 50,000 12.0 Common stock equity 650,000 16.0 a. Calculate the firm’s WACC. b. Explain how the firm can use this cost in the investment decision-making process. Please show your work.arrow_forwardPlease explain the following identity for the Weighted Average Cost of Capital or WACC. Why is the WACC important for those companies making capital investments? WACC where Re Rf + Beta (Rm - Rf) Debt Tx) ( (Debt equity) = Rd (1-Tx) - +arrow_forward
- Which of the following steps is not required when estimating a firm’s weighted average cost of capital?a. Evaluate the firm’s capital structure and determine the relative weight of each component in the mix.b. Estimate the opportunity cost of each of the sources of financing and adjust it for the effects of taxes where appropriate.c. Subtract the weighting of preferred stock and reallocate the weighting to equity and debt.d. Calculate the weighted average cost of capital by computing a weighted average of the estimated after-tax costs of the various capital sources used by the firm.e. These are all steps taken to calculate the weighted average cost of capital.arrow_forwardSource of capital Long-term debt Preferred stock Common stock equity Market value $700,000 $70,000 $400,000 Individual cost 7.6% 12.4% 14.8%arrow_forwardThe calculation of a weighted average cost of capital (WACC) involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the percentage of each type of financing in the firm’s overall capital structure. what is the symbol that represents the cost of raising capital through retained earnings in the weighted average cost of capital (WACC) equation._________ Paolo Co. has $2.56 million of debt, $2.68 million of preferred stock, and $2.02 million of common equity. The appropriate weight of the firm's debt in the calculation of the company's weighted average cost of capital is_________%.arrow_forward
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