Posted by Lamarr on Sunday, November 13, 2011 at 9:55pm.
Assume that you are the assistant to the CFO of XYZ Company. Your task is to estimate XYZ's WACC using the following data:
1. The firm's tax rate is 40%.
2. The current price of the 12% coupon, semiannual payment, non-callable bonds with 15 years to maturity is $1,153.72. New bonds could be issued with no flotation costs.
3. The current price of the firm's 10% $100 par value, quarterly dividend, perpetual preferred stock is $116.95. The flotation costs on a new issue would be 5% of the proceeds.
4. The current price of the common stock is $50 per share. The last dividend was $4.19, and dividends are expected to grow at a constant rate of 5%. The firm's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is 6%.
5. The target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.
Procedure
1. What sources of capital should be included when you estimate XYZ's WACC?
2. Should the component costs be estimated on a before or after-tax basis? Why?
3. Should the component costs be historical or marginal costs? Why?
4. What is the market interest rate on XYZ's debt and its component cost of debt?
5. What is the firm's cost of preferred stock?
6. Why is the firm's cost of preferred stock lower than the yield to maturity on its debt (Hint: Think about taxes.)
Coogly Company is attempting to identify its weighted average cost of capital for the coming year and has hired you to answer some questions they have about the process. They have asked you to present this information in a PowerPoint presentation to the company’s management team. The company would like for you to keep your presentation to approximately 10 slides and use the notes section in PowerPoint to clarify your point. Your presentation should address the following questions and offer a final recommendation to Coogly. Make sure you support your answers and clearly explain the advantages and disadvantages of utilizing the weighted average cost of capital methodology. Include at least one graph or chart in your presentation.
Company Information
The capital structure for the firm will be maintained and is now 10% preferred stock, 30% debt, and 60% new common stock. No retained earnings are available. The marginal tax rate for the firm is 40%.
Coogly has outstanding preferred stock That pays a dividend of $4 per share and sells for $82 per share, with a floatation cost of $6 per share. What is the component cost for Coogly's preferred stock? What are the advantages and disadvantages of using preferred stock in the capital structure?
If the company issues new common stock, it will sell for $50 per share with a floatation cost of $9 per share. The last dividend paid was $3.80 and this dividend is expected to grow at a rate of 7% for the foreseeable future. What is the cost of new equity to the firm? What are the advantages and disadvantages of issuing new equity in the capital structure?
The company will use new bonds for any capital project, according to the capital structure. These bonds will have a market and par value of $1000, with a coupon rate of 6% and a floatation cost of 7%. The bonds will mature in 20 years and no other debt will be used for any new investments. What is the cost of new debt? What are the advantages and disadvantages of issuing new debt in the capital structure?
Given the component costs identified above and the capital structure for the firm, what is the weighted average cost of capital for Coogly? What are the advantages and disadvantages of using this method in the capital budgeting process?
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