FIN 300 Study Guide - Final Guide: Interest Rate, European Cooperation In Science And Technology, Weighted Arithmetic Mean

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orangeturtle472

30 Oct 2014

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Fin 300 exam 1 (chapters 1,2,3,4,5,6,7,9,10 & 11) Capital component one of the types of capital used by firms to raise funds. Weighted average cost of capital (wacc) a weighted average of the components of debt, preferred stock, and common equity. Cost of preferred stock , rp the rate of return investors require on the firm"s preferred stock. Rp is calculated as the preferred dividend, dp, divided by the current price, pp. Cost of retained earnings, rs the rate of return required by stockholders on a firm"s common stock. Cost of new common stock, re the cost of external equity based on the cost of retained earnings but increase for floatation costs. The capm approach the capital asset pricing model (capm) is developed as seen in ch. Floatation cost, f the percentage cost of issuing new common stock. Floatation cost adjustment the amount that must be added to rs to account for floatation costs to find re.

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The Cost of Capital: Weighted Average Cost of Capital

The firm's target capital structure is the mix of debt, preferred stock, and common equity the firm plans to raise funds for its future projects. The target proportions of debt, preferred stock, and common equity, along with the cost of these components, are used to calculate the firm's weighted average cost of capital (WACC). If the firm will not have to issue new common stock, then the cost of retained earnings is used in the firm's WACC calculation. However, if the firm will have to issue new common stock, the cost of new common stock should be used in the firm's WACC calculation.

Quantitative Problem: Barton Industries expects that its target capital structure for raising funds in the future for its capital budget will consist of 40% debt, 5% preferred stock, and 55% common equity. Note that the firm's marginal tax rate is 40%. Assume that the firm's cost of debt, rd, is 7.5%, the firm's cost of preferred stock, rp, is 7% and the firm's cost of equity is 11.5% for old equity, rs, and 11.87% for new equity, re. What is the firm's weighted average cost of capital (WACC1) if it uses retained earnings as its source of common equity? Round your answer to 3 decimal places. Do not round intermadiate calculations.
%

What is the firmâs weighted average cost of capital (WACC2) if it has to issue new common stock? Round your answer to 3 decimal places. Do not round intermadiate calculations.
%

raspberryyak84

Weighted Average Cost of Capital

A firm has determined its optimal capital structure, which is illustrated by the information below.

Source of Capital (Target Market Proportions)

Long term debt (20%)

Preferred Stock (10)

Common Stock Equity (70)

To expand operations, the firm is considering the following sources of financing its capital expenses:

Debt -The firm can sell 12-year, 1,000 par value bond paying a 7% annual coupon for $960. To issue the bond the firm will have to pay bond issuance or flotation cost of 2 percent of the face value of the bond.

Preferred Stock- the firm has determined that it can issue preffered stock at a par value price of $75 per share. The stock will pay $10 annual dividend. The cost of issuing and selling the stock is $3 per share.

Common Stock: A firms common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. The firms dividends have been growing at a constant rate of 4% per year for the last four years and are expected to sustain that growth rate thereafter.

New common stock issue- if the firm decides to issue new common stock, its underwriter indicated that the issue will have to be underpriced by $1 below the current share price. Further, the firm will have to pay $1 per share in issuance or floatation cost.

Additionaly, the firms marginal corporate tax rate is 40 percent.

(Given the information above)

A) find the firms before-tax cost of debt financing

B) find the firms after-tax cost of debt financing

C) find the firms cost of preffered stock financing

D) find the firms cost of financing using the retained earnings

e) find the firms cost of financing using a new common stock issue

f)find the firms weighted average cost of capital, if the firm uses debt, preffered stock and retained earnings to finance its investments. Given this result, explain what rate of return the firm should require from its investors.

g) Find the firms weighted average cost of capital, if the firm uses debt, preffered stock, retained earnings, and new stock issue to finance its investments. Given this results, explain what rate of return the firm should require from its investments.

turquoiseelephant380

Strange Sights Paranormal Investigators Inc. has a target capital structure that calls for:

40% debt

10% preferred stock

50% common equity

The firms current bonds have a before tax cost of debt of 10% and the firm is in the 40% tax bracket. The firm can sell as much debt as it wishes at this rate. The firms preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will pay flotation cost of $10 per share. Strange sights' common stock sells for $40 a share with flotation costs of $6 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10% per year. Assume the firm has sufficient retained earnings to fund the equity portion of its capital budget.

1. What is the firms cost of retained earnings? (15.5%)

2. What is the firms cost of newly issued common stock? (16.5%)

3. What is the firms cost of newly issued preferred stock? (12.5%)

4. What is the firms weighted average cost of capital? (11.7%)

The answers are giving in ( ) as a guide, I must show how I got them. Please help!!!!!

peachzebra922

FIN 300 Study Guide - Final Guide: Interest Rate, European Cooperation In Science And Technology, Weighted Arithmetic Mean

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