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The firm decides to raise $30 million by selling equity and debt. The investment bankers hired by your firm contact potential investors and come back with the following numbers:

Debt that pays $1 million coupons a year and $18 million maturity value after 10 years will sell for $20 million.

Equity that pays expected dividends of $1.2 million starting next year and growing at a rate of 3 percent per year thereafter sells for $10 million.

Question 12: Calculate the cost of debt, equity, and the WACC.

Before starting your calculations, review the following materials:

cost of capital and choice of financing

equity, debt, and preferred stock

Submit your Cost of Debt Report and Calculations to the dropbox below. Be sure to show your calculations in Excel and provide a narrative analysis in PowerPoint. Your narrative analysis should summarize the results of your analysis and make recommendations for the benefit of company.

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Jean Keeling
Jean KeelingLv2
28 Sep 2019

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Your firm has decided to spin off Android01 and Processor01 as a separate firm. The owners of the new firm will be equity holders and debt holders. After speaking with potential investors, investment banks have identified two possible capital structures (structure of equity and debt ownership):

Debt holders receive debt that pays them coupons of $2 million a year, and $30 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 4 percent. Equity holders receive expected dividends of $3 million starting from year 5, and growing at a rate of 4 percent per year (a growing perpetuity). They price the equity using a discount rate of 7.5 percent.

Debt holders receive debt that pays them coupons of $1 million a year, and $12 million after 20 years (these are expected values as the coupons and principal payments are not riskless, the debt buyers realize the firms could default). They price the debt using a discount rate of 3.5 percent. Equity holders receive expected dividends of $3.9 million starting from year 5, and growing at a rate of 4.5 percent per year (a growing perpetuity). They price the equity using a discount rate of 7 percent.

Your firm receives all the proceeds from the sale debt and equity.

Prepare a Capital Budgeting and Cost of Capital report that answers the following Question 13.

Question 13: Which particular capital structure should be chosen for the spin-off?

Before starting your calculations, review the following materials:

cost of capital and choice of financing

equity, debt, and preferred stock

Submit your Capital Budgeting and Cost of Capital Report to the dropbox below.

Please answer ALL of these questions. It would really help me out! Thanks!

1. MV corporation has debt with Market value of $100 million, common equity with a book value of $100 million, and preferred stock woth $20 million outstanding. It's common equity trades at $50 per share, and the firm has 6 million shares outstanding. What weights should MV corporation use in its WACC

2. Book co. has 1.5 million shares of common stock equity with a par (book) value of $1.40, retained earnings of $28.1 million, and its shares have a market value of $51.74 per share. it also has debt with a par value of $19.1 million that is trading at 104% of par.

a. What is the market value of its equity?

b. What is the market value of its debt?

c. What weights should it use in computing its WACC?

3. Avicorp has a $10 million debt issue outstanding, with a 6% coupon rate. The debt has semiannual coupons, the next coupon is due in six months, and the debt matures in five years. It is currently priced at 95% of par value.

(a) What is Avicorp’s pretax cost of debt?

(b) If Avicor faces a 40% tax rate, what is its after-tax cost of debt? The after-tax cost of debt for Avicor is:

4. Dewyco has preferred stock trading at $50 per share. The next preferred dividend of $4 is due in one year. What is Dewyco’s cost of capital for preferred stock?

5. Steady Company's stock has a beta of 0.24. If the risk-free rate is 5.8% and the market risk premium is 7.1%, what is an estimate of Steady Company's cost of equity?

(round to one decimal place)

6. HighGrowth Company has a stock price of $20. The firm will pay a dividend of $1 next year, and its divident is expected to grow at a rate of 4% per year thereafter. What is your estimate of HighGrowth's cost of equity capital?

7. CoffeeCarts has a cost of equity of 15%, an effective cost of debt of 4%, and it's financed 70% with equity and 30% with debt. What is this firm's WACC?

8. AllCity Inc is financed 40% with debt, 10% with preferred stock, and 50% with common stock. Its pretax cost of debt is 6%. Its preferred stock pays an annual dividend of $2.50 and is priced at $30. It has an equity beta of 1.1. Assume the risk-free rate is 2%, the market risk premium is 7% and AllCity's tax rate is 35%. What is its after-tax WACC?

9. Growth company's current share price is $20 and is expected to pay a $1 dicidend per share next year. After that, the firm's dividends are expected to grow at a rate of 4% per year.

Growth company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at a par with a coupon rate of 6.5%.

a. What is Growth Company's pre-tax cost of debt?

b. Growth Company also has preferred stock outstanding that pays $2 per share fixed dividend. If the stock is currently price at $28, what is Growth Company's cost of preffered stock?

c. Growth Company has existing debt issued three years ago with a coupon rate of 6%. The firm just issued new debt at par with a coupon rate of 6.5%. What is Growth Company's pretax cost of debt?

d. Growth Company has 5 million common shares outstanding and 1 million preferred shares outstanding, at its total book value is $50 million. Its liabilitities have a market value of $20 million. If Growth Company's common and preferred shares priced as in parts a and b, what is the market value of Growth Company's assets?

e. Growth Company faces a 35% tax rate. Given the information in parts a through d, and your answers to those problems, what is Growth Company's WACC?

10. A retail coffee company is planning to open 100 new coffee outlets that are expected to generate, in total, $15 million in free cash flows per year, with a growth rate of 3% in perpetuity. If the coffee company’s WACC is 10%, what is the NPV of this expansion?

Capital Structure Analysis

Pettit Printing Company has a total market value of $100 million, consisting of 1 million shares selling for $50 per share and $50 million of 10% perpetual bonds now selling at par. The company's EBIT is $14.09 million, and its tax rate is 40%. Pettit can change its capital structure either by increasing its debt to 65% (based on market values) or decreasing it to 35%. If it decides to increase its use of leverage, it must call its old bonds and issue new ones with a 12% coupon. If it decides to decrease its leverage, it will call in its old bonds and replace them with new 8% coupon bonds. The company will sell or repurchase stock at the new equilibrium price to complete the capital structure change.

The firm pays out all earnings as dividends; hence, its stock is a zero growth stock. Its current cost of equity, rs, is 14%. If it increases leverage, rs will be 16%. If it decreases leverage, rs will be 13%.

Present situation (50% debt):
What is the firm's WACC? Round your answer to three decimal places.
%
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

65% debt:
What is the firm's WACC? Round your answer to two decimal places.
  %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

35% debt:
What is the firm's WACC? Round your answer to two decimal places.
  %
What is the total corporate value? Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to three decimal places.
$ million

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