#1) Weighted average cost capital The target capital structure for QM Industries is 42% common stock, 12% preferred stock, and 46% debt. If the cost of common equity for the firm is 18.1%, the cost of...

#1) Weighted average cost capital
#1) Weighted average cost capital
The target capital structure for QM Industries is 42% common stock, 12%
preferred stock, and 46% debt. If the cost of common equity for the firm is 18.1%, the cost of preferred stock is 10.1%, the beforetax cost of debt is 8.9%, and the firm's tax rate is 35%, what is QM's weighted average cost of capital?
QM's WACC is 11.475%? (Round to three decimal places)
Weighted average cost of capital (WACC) =
[Weight of debt * After-tax cost of debt] + [Weight of preferred stock * Cost of preferred stock] + [Weight of equity * Cost of equity]
Here, After-tax cost of debt = Before-tax cost of debt * (1 – T) = 8.9% x (1-.35) ( 5.785%
So,
WACC = [46% x 5.785%] + [12% x 10.1%] + [42% x 18.1%]
( 2.6611% + 1.212% + 7.602%
( 11.4751% (or) 11.475% rounded to 2 decimals.
#2) Weighted average cost of capital
Crypton Electronics has a capital structure consisting of 41% common stock and 59% debt. A debt issue of $1,000 par value, 5.6% bonds that mature in 15 years and pay an annual interest will sell for $975. Common stock of the firm is currently selling for $30.68 per share and the firm expects to pay a $2.15 dividend next year. Dividends have grown at the rate of 4.8% per year and are expected to continue to do so for the forseeable future. What is Crypton's cost of capital where the firm's tax rate is 30%?
Crypton's cost of capital is 7.259%? (Round to three decimal places)
Step 1: To find the before-tax cost of debt (YTM) & after-tax cost
We can find the YTM of debt using the IRR excel function as shown below.
Annual coupon amount = $1000*5.6% = $56
YearCash flows
0$975This is bond selling price, hence shown positive.
1($56)Annual coupon to be paid, hence shown negative.
2($56)Annual coupon to be paid, hence shown negative.
3($56)Annual coupon to be paid, hence shown negative.
4($56)Annual coupon to be paid, hence shown negative.
5($56)Annual coupon to be paid, hence shown negative.
6($56)Annual coupon to be paid, hence shown negative.
7($56)Annual coupon to be paid, hence shown negative.
8($56)Annual coupon to be paid, hence shown negative.
9($56)Annual coupon to be paid, hence shown negative.
10($56)Annual coupon to be paid, hence shown negative.
11($56)Annual coupon to be paid, hence shown negative.
12($56)Annual coupon to be paid, hence shown negative.
13($56)Annual coupon to be paid, hence shown negative.
14($56)Annual coupon to be paid, hence shown negative.
15($1,056)Annual coupon + Maturity value
YTM =5.855%
Please note: YTM has been calculated using the excel IRR function. If you double click on the above table, you can view it in excel format. Then, refer to the cell reference of B19 for the usage of this function.
After-tax cost of debt = Before-tax cost x (1- T) ( 5.855% x (1 - .30) ( 4.0985%
Step 2: Calculation of cost of equity
As per the dividend discount model,
Cost of equity = [D1/P0] + g
Where, D1 = Next year dividend
P0 = Current share price
G= growth rate
Cost of equity = [2.15/30.68] + .048
( 0.070078 + 0.048
( 0.118078 (or) 11.8078%
Step 3: Calculation of WACC
WACC = [Weight of debt*After-tax cost of debt] + [Weight of equity*Cost of equity]
( [59% * 4.0985%] + [41% * 11.8078%]
( 2.418% + 4.841%
( 7.259%
#3) Weighted average cost of capital
The target captial structure for Jowers Manufacturing is 45% common stock, 16% preferred stock, and 39% debt. If the cost of common equity for the firm is 19.7%, the cost of preferred stock is 11.6%, and the beforetax cost of debt is 10.2%, what is Jower's cost of capital? The firm's tax rate is 34%.
Jower's WACC is 13.346%? (or) 13.347% (Round to three decimal places)
Step 1 : To find the after-tax cost of debt
After-tax cost = Before – tax cost * (1- T)
( 10.2% * (1 - .34)
( 6.732%
Step 2: To find the WACC
[Weight of debt * After-tax cost of debt] + [Weight of preferred stock * Cost of preferred stock] + [Weight of equity * Cost of equity]
( [39% x 6.732%] + [16% x 11.6%] + [45% x 19.7%]
( 2.62548% + 1.856% + 8.865%
( 13.34648% (or) 13.346% rounded to 3 decimals.
#4) Weighted average cost of capital
As a member of the Finance Department of Ranch Manufacturing your supervisor has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm's present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm's capital structure as follows:
Source of Capital Market Values
Bonds ------------------------------- $3,600,000
Preferred stock --------------------- $1,700,000
Common stock ------------------------ $5,600,000
To finance the purchses, Ranch Manufacturing will sell
10-year bonds paying 7.1% per year at the market price of $1026. Preferred stock paying $1.92 dividend can be sold for $25.29. Common stock for Ranch Manufacturing is currently selling for $54.21 per share and the firm paid $3.07 dividend last year. Dividends are expected to cotninue growing at a rate of 5.1% per year into the indefinite future. If the firm's tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?
Ranch Manufacturing's WACC is 8.420%? (Round to three decimal places) Please note: Minor difference may occur due to rounding.
Step 1: To find the before-tax cost of debt (YTM) and after-tax cost
Annual coupon amount = $1000 * 7.1% ( $71
YearCash flows
0$1,026This is bond selling price, hence shown positive.
1($71)Annual coupon to be paid, hence shown negative.
2($71)Annual coupon to be paid, hence shown negative.
3($71)Annual coupon to be paid, hence shown negative.
4($71)Annual coupon to be paid, hence shown negative.
5($71)Annual coupon to be paid, hence shown negative.
6($71)Annual coupon to be paid, hence shown negative.
7($71)Annual coupon to be paid, hence shown negative.
8($71)Annual coupon to be paid, hence shown negative.
9($71)Annual coupon to be paid, hence shown negative.
10($1,071)Annual coupon + Maturity value
YTM = 6.734%
Please note: YTM of debt has been calculated using the IRR excel function. IF you double click on the above table, you can view it in excel format. Then, refer to the cell reference of B14 for the usage of this function.
After-tax cost of debt = 6.734% * (1 - .30) ( 4.7138%
Step 2: To find the cost of preferred stock
Cost of preferred stock = Annual dividend/Current market price
( $1.92/$25.29
( 7.592%
Step 3: To find the cost of common equity
As per the dividend discount model,
Cost of equity = [D1/P0] + g
Here, D0 = $3.07 (the last year dividend)
So, D1 = D0*(1+g) = 3.07 * (1+.051) ( 3.22657
Cost of equity = [3.22657/54.21] + .051
( 0.11052 (or) 11.052%
Step 4: To find the weights of respective capitals
    Source
     
    MV
    Weights
    Bonds
     
    $3,600,000
    33.03%
    Preferred stock
     
    $1,700,000
    15.60%
    Common stock
     
    $5,600,000
    51.38%
    Total capital
     
    $10,900,000
    100.00%
For example, weight of bonds = MV of bond/Total capital = 3,600,000/10,900,000 = 33.03% and similarly for other 2.
Step 5: To calculate WACC
[Weight of debt * After-tax cost of debt] + [Weight of preferred stock * Cost of preferred stock] + [Weight of equity * Cost of equity]
( [33.03% * 4.7138%] + [15.60% * 7.592%] + [51.38% * 11.052%]
( 1.557% + 1.18435% + 5.6785%
( 8.4198% (or) 8.420%
#5) EBIT-EPS Analysis
Abe Forrester and three of his friends from college have interested a group of venture capitalists in backing their business idea. The proposed operation would consist of a series of retail outlets to distribute and service a full line of vacuum cleaners and accessories. The stores would be located in Dallas, Houston, and San Antonio. To finance the new venture two plans have been proposed:
* Plan A is an all-common-equity structure in which...