SMG FE 323 Chapter Notes - Chapter Ch. 13: Capital Budgeting, Net Present Value, Capital Asset Pricing Model

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15 Mar 2017

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Equity) (equity cost of capital) + fraction of. Firm value financed by debt) (debt cost of. 2: cost of equity = risk-free rate + equity beta * Market risk premium: constant dividend growth model, cost of equity = dividend (in one year)/ current price. Assume that any other factors are not significant at the level of debt chosen: assumptions in practice these assumptions are reasonable for many projects and firms. Likely to fit typical projects of firms with investment concentrated in a single industry. Market risk depends on sensitivity of industry to economy. Reflects the fact that firms tend to increase their levels of debt as they grow larger; some may even have an explicit target for their debt- equity ratio. For firms without very high levels of debt, the interest tac deduction is likely to be the most important factor affecting the capital budgeting decision: wacc method application: extending the life of a dupont.

Related Questions

The calculation of WACC involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the percentage of each type of financing in the firm's overall capital structure.

Re is the symbol that represents the cost of raising capital by issuing new stock in the weighted average cost of capital (WACC) equation.

Reymond Co. has $1.1 million of debt, $1 million of preferred stock, and $2.1 million of common equity. What would be its weight on common equity?

a) 0.19

b) 0.24

c) 0.50

d) 0.22

beigemacaw797

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

Given the following information for Lightning Power Co., find the WACC. Assume the companyâs tax rate is 35 percent.

Debt: 8,000 6.5 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 106 percent of par;the bonds make semiannual payments.

Common stock: 310,000 shares outstanding, selling for $57 per share; the beta is 1.05.

Preferred stock: 15,000 shares of 4 percent preferred stock outstanding, currently selling for $72 per share.

Market: 7 percent market risk premium and 4.5 percent risk-free rate.

1. If a firm plans to issue debt to finance their next project then, they should discount the project's cash flows by:

The weighted cost of debt

The after tax cost of debt

The YTM

The historical cost of debt

None of the above

2. The WACC is:

The historical cost of raising funds in the market.

The arithmetic average cost of raising capital.

The marginal cost of raising funds in the market today.

The discount rate only if we raise funds from all sources of capital.

None of the above.

3. What is the weighted cost of capital?

4. Equity is what portion of the capital structure of the firm?

5. The weighted cost of debt is?

SMG FE 323 Chapter Notes - Chapter Ch. 13: Capital Budgeting, Net Present Value, Capital Asset Pricing Model

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