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ACC 312 Study Guide - Midterm Guide: Capital Asset, Capital Asset Pricing Model

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greenwalrus59
30 Nov 2017
School
UT-Austin
Department
Accounting
Course
ACC 312
Professor
B Lendecky

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Document Summary

Both the cost of debt and the cost of equity are based on future income flows, and the risk associated with such returns. The cost of servicing debt capital is the yearly or half yearly interest payment, which is an allowable expense for tax. The cost of irredeemable loan capital to a company may be calculated as follows: d = i x (1- t) L where d = cost of debt capital i = annual loan interest rate. L = the current market value of the loan t = the rate of corporation tax. The market value of the debt is dependent on the level of future returns, the interest rate paid, which is determined by the level of risk associated with the investment. In the case of equity or ordinary shares the future income is dividends. A difference between this method and the method applied to debt is that there is no tax relief for dividend payments.

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Related Questions

You have the following information about Burgundy Basins, a sinkmanufacturer.

Equity sharesoutstanding 20 million

Stock price pershare $40.00

Yield to maturity ondebt 7.5%

Book value of interest-bearingdebt $320 million

Coupon interest rate ondebt 4.8%

Market value ofdebt $290 million

Book value ofequity $500 million

Cost of equitycapital 14%

Taxrate 35%

Burgundy is contemplating what for the company is anaverage-risk

investment costing $40 million and promising an annual after-taxcash

flow of $6.4 million in perpetuity.

b. Whatis Burgundy's weighted-average cost of capital?

Isnt't the calculated tax rate suppose to be (1-0.35 = 0.65),you have 7.5%? How was the the Debt + Equity calculated? You say itis 800. How was that calculated?

b.WACC = cost of debt*Debt proportion + cost of equity *equityproportion = 7.5%*290/(290+800) + 14%*500/(290+800) = 1.99% +10.27% = 12. 26% How was 800 calculated?

Merger Valuation with the CAPV Model

Hastings Corporation is interested in acquiring Vandell Corporation. Vandell currently has 1 million shares outstanding and a target capital structure consisting of 30% debt; its current beta is 1.10 (i.e., based on its target capital structure). Vandell's debt interest rate is 7.8%. Assume that the risk-free rate of interest is 5% and the market risk premium is 8%. Both Vandell and Hastings face a 40% tax rate.

Hastings Corporation estimates that if it acquires Vandell Corporation, synergies will cause Vandell’s free cash flows to be $2.5 million, $3.1 million, $3.4 million, and $3.73 million at Years 1 through 4, respectively, after which the free cash flows will grow at a constant 5% rate. Hastings plans to assume Vandell’s $10.61 million in debt (which has an 7.8% interest rate) and raise additional debt financing at the time of the acquisition. Hastings estimates that interest payments will be $1.6 million each year for Years 1, 2, and 3. After Year 3, a target capital structure of 30% debt will be maintained. Interest at Year 4 will be $1.408 million, after which the interest and the tax shield will grow at 5%.

What is Vandell’s pre-acquisition levered cost of equity? What is its unlevered cost of equity? Round your answer to two decimal places. Do not round intermediate calculations.
Pre-acquisition levered cost of equity: %
Unlevered cost of equity: %

What is the intrinsic unlevered value of operations at t = 0 (assuming the synergies are realized)? Round your answer to the nearest cent. Do not round intermediate calculations.
$

What is the value of the tax shields at t = 0? Round your answer to two decimal places. Do not round intermediate calculations.
$ million

What is the total intrinsic value of operations at t = 0? What is the intrinsic value of Vandell’s equity to Hastings? What is Vandell’s intrinsic stock price per share? Round your answer to two decimal places. Do not round intermediate calculations.
Value of operations: $ million
Equity value to acquirer: $ million
Intrinsic value per share of existing shares to acquirer: $ /share

Estimating Market and Book Values and Cost of CapitalMeasures

The December 31, 2007, partial balance sheet and the 2007 retainedearnings statement from Colgate-Palmolive Company (CL) follow ($millions, except per share amounts). The website Finance.Yahoo.comreported that the total market capitalization of Colgate-Palmolivewas $39.91 billion and its stock price was $78.40 as of December31, 2007. Also, Yahoo estimates its total enterprise value at$42.49 billion, and its market beta at 0.46. In addition,Colgate-Palmolive's average pretax borrowing cost is 4.80%, and itsmarginal tax rate is 35%. Assume that the risk-free rate equals5.30% and the market premium equals 5.70%.

Liabilities and Shareholders'Equity
Notes and loans payable $ 155.9
Current portion of long-term debt 138.1
Accounts payable 1,066.8
Accrued income taxes 262.7
Other accruals 1,539.2
Total current liabilities 3,162.7
Long-term debt 3,251.9
Deferred income taxes 264.1
Other liabilities 1,177.1
Total liabilities 7,855.8
Shareholders' Equity
Preferred stock 197.5
Common stock, $1 par value (1,000,000,000 share
authorized, 732,853,180 shares issued)		 732.9
Additional paid-in capital 1,517.7
Retained earnings 10,627.5
Accumulated other comprehensive income (1,666.8)
11,408.8
Unearned compensation (218.9)
Treasury stock, at cost (8,903.7)
Total shareholders' equity 2,286.2
Total liabilities and shareholders' equity $10,142.0
Common Shares Outstanding
Balance, December 31, 2006 512,658,587
Shares issued for stock options 10,051,559
Treasury stock acquired (18,062,892)
Other 4,387,547
Balance, December 31, 2007 509,034,801

(a) Verify Yahoo's computation of Colgate-Palmolive's marketcapitalization using the data from its financial report excerptsabove. (Round your answer to two decimal places.)
Market capitalization = $Answer

x Answer

shares = $Answer

billion

(b) Compute the book value of Colgate-Palmolive's long-term debt asof December 31, 2007.
$Answer

million

(c) Compute the market value of Colgate-Palmolive's debt using thedata from Yahoo. (Round your answer to two decimal places.)
$Answer

billion

(d) Identify reasons behind the difference between the amountscomputed in parts (b) and (c). (Select all that apply.)
Answeryesno

The market price of Colgate-Palmolive's debt changed in value onDecember 31, 2007.
Answeryesno

The market value of debt doesn't include the issuing of newtreasury stock.
Answeryesno

The market value and book value of debt differs due toaccounting usage of historical cost.
Answeryesno

Yahoo.Finance.com might include other liabilities, such as leaseobligations, in the calculation of debt.

(e) Compute Colgate-Palmolive's cost of debt capital. (Round youranswer to one decimal place.)
Answer

%

(f) Compute Colgate-Palmolive's cost of equity capital. (Round youranswer to one decimal place.)
Answer

%

(g) Using your rounded answer from (e) and (f) above, computeColgate-Palmolive's weighted average cost of capital. Use themarket capitalization from Yahoo.Finance.com and your roundedanswer from (c) above for this calculation. (Do not round untilyour final answer. Round answer to one decimal place.)
Answer

%