Escolar Documentos
Profissional Documentos
Cultura Documentos
Assignment
Arnold Athletic Supplies Case, Questions 11-19
GROUP 7
NEHA JATIYA 179
DEEPAK SONAWANE 177
ALIEU MANNEH 178
SHRUTI GARG 156
KUMAR RAVI 129
RUBY PAYAL 152
Case study – Cost of capital
Arnold Athletic Supplies, INC. is a stall, publicly held company located between Dallas and Fort
Worth. Arnold manufactures a variety of supplies and small equipment used by players and coaches
around the country. Over the past 15 years, Arnold has had particular success in the high school
and junior college markets; its products can be found in most dressing rooms of football, and
basketball teams throughout the Southwest and Midwest.
Arnold is considering expanding into product lines. Its well established sales force will be able to
handle supplies and equipment for sports such as swimming, golf and track through it’s a current
activities in high school and junior colleges. The marketing manager and the director of finance
have begun working on figures, related to the profitability of different athletic supplies and
equipment. At this time, five possible markets have been identified and the likely return on a cash
flow basis has been determined for each. Specific proposals have been drafted and will soon be
available for internal distribution in the company. In the meantime, the president has been given
the after tax internal rates of return for each proposal as follows:
At a meeting of the board of directors called to discuss the proposal, the director of finance
presented financial data, including the current year’s balance sheet and income statement. He
reported that the stock was selling for $30 per share and that the firm’s sale and earnings were
growing at a respectable 9% annually.
As the discussion shifted from the specific proposals to the need for financing, the director of
finance was asked to make a recommendation. He had been studying different possibilities and was
prepared to discuss specifics. “I recommend,” he began, “that we do not attempt to raise separate
funds for a series of small projects. Rather, I suggest that we prepare to raise $5 million to cover
whatever proposals are finally accepted by this board. If this seems logical, I have investigated
three alternatives that currently seem to be possible.
1. We can issue $4 million in bonds. Our investment banker believes that we would be able to
float a $5,400,000 offering with a 10% coupon to net us the $5 million. If this is done we will
have a debt equity ratio near 1/1, an acceptable ratio for our firm.
2. We can sell 51,177 shares of preferred stock. Our banker feels that a 6% offering would be
successful and would net us $5 million as $ 100 par. Most of the shares would probably be
purchased by our existing common shareholders, but a strong market seems to exist
generally and I would expect no problems with this alternative.
3. We could issue common stock. Our banker thinks that we can sell 2,40,000 shares at $22
per share. From this amount, we would have to deduct fees of approx $2,80,000, which
would leave us with $ 5 million net.”
After the presentation by the director of finance, the board began to discuss the different
possibilities. Finally the board began to discuss the cutoff point for the acceptance of the different
proposals. One board member inquired about the firm’s present required return, as basically a
medium risk investment. Dir of fin agreed to developed data on the required returns and how they
would affect the acceptance of each of the 5 proposals.
Questions:
1. What is the firm’s current required rate of return? What would it be with each of three
means of financing.
2. Which projects are acceptable under each financing method?
Solution
Current Operations
Tax Rate 36%
Common Stock ($1 par) 1100000
Notes Payable, Current (15%) 630000 15% 94500
Financing Option : 1
Kd(new)
Par value 5400000
Net Proceeds 5000000
Coupon Rate 10%
Tax Rate 0.36
No. of years (assumed) 10
Interest payable 540000
Kd(new)= Interest/Market value * (1-tax rate)
Irredeemable 6.92%
Redeemable 7.15% Interest+(Par- Net Proceeds)/n(1-t)/(Par+Net proceeds)/2
Financing Option : 2
Kp(new)
No. of shares issued 51177
Par value per share 100
Total book value 5117700
Total market value 5000000
Dividend rate 6%
Total Dividend 307062
Dividend/ Market value of
Kp(new)= Prefrence shares
6.14%
Financing Option : 3
Ke(new)
Dividends 0.60
Market price (new) 22.00
Growth Rate 9%
Flotation Cost 1.17
Ke(new)= (Dividend/(MP-Flotation cost))+Growth rate
11.88%
12. (Cost of Preferred Stock) the preferred stock of Walter Industries sells for Rs52 and pays Rs5.80 in
dividends. The net price of the security after issuance costs is Rs40.00. What is the cost of capital for
the preferred stock?
Current Market
52
price
Dividends 5.8
Net Price 40
13. (Cost of Debt) The Zephyr Corporation is contemplating a new investment to be financed with 40
percent from debt. The firm could sell new Rs1,000 par value bonds at a net price of Rs 935. The
coupon interest rate is 11 percent, and the bonds would mature in 12 years. If the company is in 40
percent tax bracket, what is the after tax cost of capital to Zephyr for bonds?
15. (Cost of Internal Equity) Pathos Co.’s common stock is currently selling for Rs70.50. Dividends paid
last year were Rs.68. Flotation costs on issuing stock will be 11 percent of market price. The
dividends and earnings per share are projected to have an annual growth rate of 12 percent. What is
the cost of internal common equity for Pathos?
Cost of internal equity = [(next year's dividend per share/(current market price per share - flotation
costs)] + growth rate of dividends.
D(1+g)/MP- FC
Cost of internal common equity 76.16
62.745
Dividend Next year 76.16
Internal Common equity 15%
16.(Cost of Equity) The common stock for the Bestsold Corporation sells for Rs81. If a new issue is sold,
the flotation cost is estimated to be 7 percent. The company pays 45 percent of its earnings in
dividends, and a Rs5 dividend was recently paid. Earnings per share five years ago were Rs10.
Earnings are expected to continue to grow at the same annual rate in the future as during the past
five years. The firm’s marginal tax rate is 40 percent. Calculate the cost of (a) internal common and
(b) external common.
MP 81
FC 7%
Dividend 45% of MP
Dividend recently paid Rs.5
floatation cost 7%
Earnings 5 years ago Rs10
Earnings now 11.11111111
R 2.10% Fv=pv(1+r)n
Cost of internal equity= 8.43%
cost of external equity= 8.90%
17. (Cost of Debt) Sincere Stationery Corporation needs to raise Rs600,000 to improve its manufacturing
plant. It has decided to issue a Rs1,000 par value bond with a 14 percent annual coupon rate and a
10-year maturity. If the investors require a 13 percent rate of return.
18. (Weighted cost of Capital) The capital structure for the Carrion Corporation is provided below. The
company plans to maintain its debt structure in the future. The firm has a 7.00 percent cost of debt,
a 15 percent cost of preferred stock, 6.5 percent cost of common stock, what is the firm’s weighted
cost of capital?
Capital structure (Rs000)
Common stock
Weighted cost of capital: it is the rate the comp[any has to pay to the providers of capital to finance
the Assets of the company. It is also called as cost of Capital.
Weighted
Percentage cost of Cost of
Particulars Amount computation capital Capital
Debt 70,00,000 7000000/15000000 46.67% 7.00% (46.7%x7%) 3.27%
Prefered Stock 3500000 3500000/15000000 23.33% 15% (23.33%x15%) 3.50%
Common Stock 4500000 4500000/15000000 30.00% 6.50% (30%x6.50%) 1.95%
Total 15000000 8.72%
Weighted cost of
Capital = 8.72%
19. (Marginal Cost-of-Capital Curve) The Zenor Corporation is considering three investments. The costs
and expected returns of these projects are shown below:
B 250,000 13
C 120,000 10
The firm would finance the projects by 45 percent debt and 55 percent common equity. The after-
tax cost of debt is 7.5 percent. Internally generated common totaling Rs200,000 is available, and the
common stockholders’ required rate of return is 20 percent. If new stock is issued the cost will be 28
percent.
The firm has enough capital to invest and undertake any of the projects. We only have investment cost
given and not the Net present value.
Hence our Deceision is base on IRR. However only project A has IRR greather than the WACC