1. (defining capital structure weights) templeton extended care facilities, inc. is considering the acquisition of a chain of cemeteries for $340 million. Since the primary asset of this business is real estate, templeton’s management has determined that they will be able to borrow the majority of the money needed to buy the business. The current owners have no debt financing but templeton plans to borrow $310 million and invest only $120 million in equity in the acquisition. What weights should templeton use in computing the WACC for this acquisition? (round to one decimal place).
2. (individual or component costs of capital) compute the cost of the capital for the firm for the following:
A. A bond that has a $1,000 par value (face value) and a contract or coupon interest rate of 10.8%. the bonds have a current market value of $1,130 and will mature in 10 years. The firm’s marginal tax rate is 34%.
B. A new common stock issue that paid a $1.81 dividend last year. The firm’s dividends are expected to continue to grow at 7.4% per year forever. The price of the firm’s common stock is now $27.18.
C. A preferred stock paying a 8.1% dividend on a $121 par value.
D. A bond selling to yield 11.9% where the firm’s tax rate is 34%.
(round to two decimal places).
3. (individual or component costs of capital) your firm is considering a new investment proposal and would like to calculate its weighted average cost of capital. To help this, compute the cost of capital for the firm for the following:
A. A bond that has $1,000 par value (face value) and a contract or coupon interest rate of 12.8%. the bond is currently selling for a price of $1,128 and will mature in 10 years. The firm tax rate is 34%.
B. If the firm’s bonds are not frequently traded, how would you go about determining a cost of debt for this company?
C. A new common stock issue that paid a $1.77 dividend last year. The par value of the stock is $15, and the firm’s dividends per share have grown at a rate of 8.8% per year. This growth rate is expected to continue into the foreseeable future. The roice of this stock is now $28.05.
D. A preferred stock paying a 9.2% dividend on a $123 par value. The preferred shares are currently selling for $146.41.
E. A bond selling to yield 13.7% for the purchaser of the bond. The borrowing firm faces a tax rate of 34%.
(round to two decimal places)
1. To compute the weights for Templeton's capital structure for the acquisition, we need to determine the proportion of debt and equity in the total investment.
The total acquisition cost is $340 million. Templeton plans to borrow $310 million and invest $120 million in equity. Therefore, the weights can be calculated as follows:
Weight of debt = Borrowed funds / Total investment
= $310 million / $340 million
= 0.9118 (rounded to four decimal places)
Weight of equity = Equity investment / Total investment
= $120 million / $340 million
= 0.3529 (rounded to four decimal places)
The weights Templeton should use in computing the Weighted Average Cost of Capital (WACC) for this acquisition are 0.9118 for debt and 0.3529 for equity.
2. A. To calculate the cost of the bond, we need to consider the yield to maturity and the tax rate. The coupon rate is given as 10.8% of the par value, which is $1,000.
Yield to maturity = (Coupon payment + ((Face value - Market value) / Number of years)) / ((Face value + Market value) / 2)
= (0.108 * $1,000 + (($1,000 - $1,130) / 10)) / (($1,000 + $1,130) / 2)
= 0.0580 (rounded to four decimal places)
After considering the tax rate of 34%, the after-tax cost of debt is:
Cost of debt = Yield to maturity * (1 - Tax rate)
= 0.0580 * (1 - 0.34)
= 0.0382 (rounded to four decimal places)
B. The cost of common stock can be calculated using the Dividend Discount Model (DDM):
Cost of common stock = Dividend / Stock price + Dividend growth rate
= $1.81 / $27.18 + 0.074
= 0.1324 (rounded to four decimal places)
C. The cost of preferred stock can be calculated using the dividend payment and the stock price:
Cost of preferred stock = Dividend / Stock price
= 0.081 * $121 / $121
= 0.081 (rounded to three decimal places)
D. The cost of debt for a bond selling to yield 11.9% (before tax) can be calculated as follows:
Cost of debt = Yield to maturity
= 0.119 (rounded to three decimal places)
After considering the tax rate of 34%, the after-tax cost of debt is:
Cost of debt = Yield to maturity * (1 - Tax rate)
= 0.119 * (1 - 0.34)
= 0.0785 (rounded to four decimal places)
3. A. To calculate the cost of the bond, we need to consider the yield to maturity and the tax rate. The coupon rate is given as 12.8% of the par value, which is $1,000.
Yield to maturity = (Coupon payment + ((Face value - Market value) / Number of years)) / ((Face value + Market value) / 2)
= (0.128 * $1,000 + (($1,000 - $1,128) / 10)) / (($1,000 + $1,128) / 2)
= 0.0967 (rounded to four decimal places)
After considering the tax rate of 34%, the after-tax cost of debt is:
Cost of debt = Yield to maturity * (1 - Tax rate)
= 0.0967 * (1 - 0.34)
= 0.0637 (rounded to four decimal places)
B. If the firm's bonds are not frequently traded, it can be challenging to determine the market yield. In this case, alternative methods may be used, such as estimating the cost of debt based on comparable companies or using the yield on publicly traded bonds with similar risk and maturity.
C. The cost of common stock can be calculated using the Dividend Discount Model (DDM):
Cost of common stock = Dividend / Stock price + Dividend growth rate
= $1.77 / $28.05 + 0.088
= 0.1361 (rounded to four decimal places)
D. The cost of preferred stock can be calculated using the dividend payment and the stock price:
Cost of preferred stock = Dividend / Stock price
= 0.092 * $123 / $146.41
= 0.0770 (rounded to four decimal places)
E. The cost of debt for a bond selling to yield 13.7% (before tax) can be calculated as follows:
Cost of debt = Yield to maturity
= 0.137 (rounded to three decimal places)
After considering the tax rate of 34%, the after-tax cost of debt is:
Cost of debt = Yield to maturity * (1 - Tax rate)
= 0.137 * (1 - 0.34)
= 0.0906 (rounded to four decimal places)