MyFinanceLab With eText - Access (Custom Package)
15th Edition
ISBN: 9781269945684
Author: Pearson
Publisher: PEARSON
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Textbook Question
Chapter 9, Problem 9.13P
WACC: Market value weights The 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% |
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.
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The 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.
Chapter 9 Solutions
MyFinanceLab With eText - Access (Custom Package)
Ch. 9.1 - Prob. 1FOECh. 9.1 - What is the cost of capital?Ch. 9.1 - Prob. 9.2RQCh. 9.1 - Prob. 9.3RQCh. 9.1 - What are the typical sources of long-term capital...Ch. 9.2 - Prob. 9.5RQCh. 9.2 - Prob. 9.6RQCh. 9.2 - Prob. 9.7RQCh. 9.3 - How would you calculate the cost of preferred...Ch. 9.4 - What premise about share value underlies the...
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- The income statement comparison for Rush Delivery Company shows the income statement for the current and prior year. A. Determine the operating income (loss) (dollars) for each year. B. Determine the operating income (percentage) for each year. C. The company made a strategic decision to invest in additional assets in the current year. These amounts are provided. Using the total assets amounts as the investment base, calculate the ROI. Was the decision to invest additional assets in the company successful? Explain. D. Assuming an 8% cost of capital, calculate the RI for each year. Explain how this compares to your findings in part C.arrow_forwardCALCULATING 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?arrow_forwardWACC 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 firms 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 25%. Elliott estimates that if it had no debt, its unleveled beta, bU, would be 1.2. a. What is the firms optimal capital structure, and what would be its WACC at the optimal capital structure? b. If Elliotts managers anticipate that the companys business risk will increase in the future, what effect would this likely have on the firms target capital structure? c. If Congress were to dramatically increase the corporate tax rate, what effect would this likely have on Elliotts 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.arrow_forward
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