Cost of Capital.notebook November 17, 2015 Cost of Capital 41. Debt -Interest 2. Equity -Dividends * Preferred Stock * Common Stock (Retained Eamings vs NewSStock) 1 $1000= Ny Cost of Debt 1 annual inert in dollars [y= net proceed from the sal of debe (bona) = numberof yeas to the bond's matueity Seling NewStock (Concept of cost of capital Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm luring the past month were projects 263 and 264, The basic variables surrounding cach project analysis and the resulting decision actions are summarized in the fol- lowing table. Project 263 Project 264 Cost, $64,000 $58,000 es as . Za, se D Plxvw:as Sa sey E fh Kez %0 Cost (after-tax) 7% 16% ae Evaluate the firm’s decision-making procedures, and explain why the acceptance of project 263 and rejection of project 264 may not be in the owners’ best interest. . IF the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table. If the firm had used the weighted average cost calculated in part b, what actions would have been indicated relative to projects 263 and 264? Compare and contrast the firm’s actions with your findings in part e. Which deci- sion method seems more appropriate? Explain why.Cost of Capital.notebook November 17, 2015 Tac Valve Bond _Life(years) Underwriting fee A 20 525 B 16 40 © 15 30 D 25 15 E 22 20 wget the no’ alternatives. Ty 3 x (1-9) = 69x (1- 0-48) 69K 06 yay Q, (years) copon Tine Eee N Par a om ie BOF E 2 c 6 7 an: fH P9-S The cost of debt Gronseth Drywall Systems, Inc. is in discussions with its invest- ment bankers regarding the issuance of new bonds. The investment banker has informed the firm that different matutitics will carry different coupon rates and sell at different prices. The firm must choose among several alternatives. In each case, the bonds will have a $1,000 par value and flotation costs will be $30 per bond. The company is taxed at a rate of 40%. Calculate the after-tax cost of financing with 1600 - 1220 w+ Premios sent Ty lwo eso so 2 2% Sona to = They Ito M=692Cost of Capital.notebook November 17, 2015 8-7 Cost of preferred stock Taylor Systems has just issued preferred stock. The stock hhas a 12% annual dividend and a $100 par value and was sold at $97.50 per share. In addition, flotation costs of $2.50 per share must be paid. a. Calculate the cost of the preferred stock. bb, If the firm sells the preferred stock with a 10% annual dividend and nets $90.00 after flotation costs, what is its cost? D> 2 ops & NF GF a 10 ae ih P9-11 Retained earnings versus new common stock Using the data for cach firm shown in the following table, calculate the cost of retained earnings and the cost of new ‘common stock using the constant-growth valuation model. Projected Current market Dividend dividend per Underpricing Flotation cost Firm price pershare growth rate sharenext year __per share per share A $50.00 8% $225 $2.00 $1.00 B 20.00 4 1.00 0.50 150 & 42.50 6 2.00 1.00 2.00 D 13.00 2 210 130 1.70 Dd C, ZY a =) = ——+.0 wr) a t 7O-04E4 og =IED . 22 “So * OF + Ooyr eof 2lesQCost of Capital.notebook November 17, 2015 379-1. Individual costs and WACC Humble Manufacturing i interested in measuring its ‘overall cost of capital. The firm isin the 40% tax bracket. Curren investigation has fathered the following data: Debt The firm can raise debe by selling $1,000-par-value, 10% coupon interest sate, L0-vear bonds on which ounaal interest pavments wil be made, To ell the issue, an average discount of $30 per hond must be given. The fem muse also pay flotation costs of §20 per bond. Prefered stock The firm can sll 11% (annual dividend) preferred stock at its $100-pershare par value. The cov of issuing and selling the preferred stock is ‘expected to he $4 per share ‘Common stock The firms common stock is currently selling for $80 per share. “The firm expects to pay cash dividends of 86 per share next year The frm’ di lends have been growing stan anal rate of 6%, and this ate expected to ‘continue inthe future. The stock will have to he tnderpriced by 84 per share, and flotation costs are expected to amount to $4 per share. Retained earnings The firm expocts to have $225,000 of retained earnings ‘available in the coming year. Once these retained earnings are exhausted, the fim, ‘wil ose new common stock as the Form of common stock equity financing. Calculate the indiviaal cost of each source of financing. (Round to the nearest 0.1%.) Calculate the firm's weighted average cost of capital using the weights shown in the following table, which ar based on the firms target capital structure propor- tons. (Round tothe nearest 0.1%.) Soare of aia eng debe Prd atck Common ack sy lor