Chapter 9 – Index of Sample Problems

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Transcript Chapter 9 – Index of Sample Problems

Chapter

15

Cost of Capital

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter 15 – Index of Sample Problems • • • • • •

Slide # 02 - 07 Slide # 08 - 09 Slide # 10 - 15 Slide # 16 - 19 Slide # 20 - 23 Slide # 24 - 27 Cost of equity Cost of preferred Cost of debt Portfolio weights Weighted average cost of capital (WACC) Flotation costs

Required return, appropriate discount rate, cost of capital

• •

Net Present Value Security Market Line (SML)

R E R f

E

(

R M

R f

)

The cost of capital dependents primarily on the use of the funds, not the source.

Cost of equity

Dividend growth model

R E

D

1

P

0 

g

SML

R E R f

E

(

R M

R f

)

2: Cost of equity

Isabelle Thomas and Son, Inc. just paid the annual dividend on their common stock in the amount of $1.20 per share. The company expects to maintain a constant 3% rate of growth in their dividend payments. Currently, the stock is selling for $20.40 a share.

What is the cost of equity for Isabelle Thomas and Son, Inc.?

3: Cost of equity R E   D 1  g P 0 D 0  ( 1  g )  g P 0 $ 1 .

20  ( 1  .

03 )   .

$ 20 .

40 0606  .

03  .

03  .

0906  9 .

06 %

4: Cost of equity

The Curtis Plane Co. has paid $1.10, $.90, $.83 and $.75 in annual dividends over the past four years, starting with the latest year first. This year the company is paying a dividend of $1.22 a share.

What is the average growth rate of the dividends?

$1.22

$1.10

$ .90

$ .83

$ .75

5: Cost of equity ($1.22 - $1.10)  $1.10 = .10909

($1.10 - $.90)  $.90 = .22222

($.90 - $.83)  $.83 = .08434

($.83 - $.75)  $.75 = .10667

--- -- Total .52232

Average growth rate  .52232

4  .

13058  13 .

06 %

6: Cost of equity

The stock of Neal & Co. has a beta of 1.40. The risk-free rate of return is 3.5% and the risk premium is 8%.

What is the expected rate of return on Neal & Co. stock?

7: Cost of equity R E   R f   E  ( R m .

035  1 .

4  .

08  .

035  .

112  R f )  .

147  14 .

7 %

Cost of Preferred stock

Fixed dividend payment

R P

D P

0

8: Cost of preferred

The 7% preferred stock of Anderson, Inc. is selling for $72.92.

What is the cost of preferred stock?

9: Cost of preferred R P   D P 0 .

07  $ 100 $ 72 .

92  $ 7 .

00 $ 72 .

92  .

0960  9 .

60 %

Cost of debt

The yield of issuing bond

10: Cost of debt

The bonds of TA, Inc. have a face value of $1,000 per bond, mature in 13 years, and pay 8% interest annually. These bonds currently sell for $969.08.

What is the pre-tax cost of debt?

11: Cost of debt

Enter 13

969.08

N I/Y 80 1,000 PV PMT FV Solve for 8.4

12: Cost of debt

Four years ago, JE, Inc. issued twenty-year bonds that have a face value of $1,000 per bond and pay interest semi-annually. These bonds currently sell for $1,012.30 and have a 9% coupon. What is the pre-tax cost of debt?

13: Cost of debt

Enter (20-4)

2 /2

1,012.30

N I/Y 90/2 1,000 PV PMT FV Solve for 8.85

14: Cost of debt

The pre-tax cost of debt for Morrison and Sons is 8.78%. The tax rate is 35%.

What is the after-tax cost of debt for Morrison and Sons?

15: Cost of debt After tax cost of debt  .0878

 (1 .35)  .0878

 .65

 .05707

 5.71%

Weighted Average Cost of Capital (WACC)

• •

V=E+D TC=corporate tax rate

WACC E E V D V R D WACC V E E P R p V V D R D T C

)

T C

)

16: Portfolio weights

Wilson and Ruth, Inc. has 720,000 shares of common stock outstanding at a market price of $32.10 per share. They also have 50,000 shares of preferred stock outstanding at a price of $45 a share. The company has 20,000 bonds outstanding that are currently selling at 98% of face value and mature in 9 years. The bonds carry a 6% coupon and pay interest annually. The bonds have a face value of $1,000. The tax rate is 34%.

What are the portfolio weights that should be used in computing the weighted average cost of capital?

17: Portfolio weights Common stock (E) Preferred stock (P) Debt (D) Totals (V) 720,000  50,000  $32.10

$45.00

$23,112,000 $ 2,250,000 $44,962,000 51.4% 5.0% 20,000  $1,000  .98

$19,600,000 43.6% 100.0%

18: Portfolio weights

The Winston James Co. has a debt-equity ratio of .65. The company has no preferred stock outstanding.

What is the portfolio weight of the debt?

19: Portfolio weights Debt/equity = .65

Debt = .65

Equity = 1.00

Value = 1.65

Weights .65  1.00  1.65 = .3939 = 39.39% 1.65 = .6061 = 60.61% Total = 1.0000 100.00%

20: Weighted average cost of capital

A firm has a debt-equity ratio of .45 and a tax rate of 34%. The cost of equity is 9.4% and the pre-tax cost of debt is 8%.

What is the weighted average cost of capital?

21: Weighted average cost of capital Debt Equity Value = .45

= 1.00

= 1.45

.45  1.00  1.45 = .31

1.45 = .69

Total = 1.00

WACC   [.

E V  69 R  E  .

094 ] D V   [.

R 31 D   ( 1 .

08   T c ( 1 )  .

34 )]  .

06486  .

016368  .

081228  8 .

12 %

22: Weighted average cost of capital

Merilee, Inc. maintains a capital structure of 40% equity, 15% preferred stock and 45% debt. The cost of equity is 12% and the cost of preferred is 9%. The pre-tax cost of debt is 8%. The tax rate is 35%.

What is the weighted average cost of capital?

23: Weighted average cost of capital WACC   E  R V [.

40  E  .

12 ] P  R V  [.

15 P   D V .

09 ]   R D  [.

45  ( 1  .

08  T c ( 1 )  .

35 )]  .

048  .

0135  .

0234  .

0849  8 .

49 %

24: Flotation costs

The Silow Co. maintains weights of 55% equity, 10% preferred stock and 35% debt. The flotation costs are 8% for equity, 9% for preferred and 4% for debt.

What is the weighted average flotation cost?

25: Flotation costs Average flotation cost  (.55

 .08)  (.10

 .09)  (.35

 .04)  .

044  .

009  .

014  .

067  6 .

7 %

26: Flotation costs

Your company maintains a debt/equity ratio of .60. The flotation cost for new equity is 12% and for debt it is 6%. The firm is considering a new project which will require $5 million in external funding.

What is the initial cost of the project including the flotation costs?

27: Flotation costs Debt Equity Value = .60

= 1.00

= 1.60

.60  1.60 = .375

1.00  1.60 = .625

Total = 1.000

Average flotation cost  (.625

 .12)  (.375

 .06)  .075

 .0225

 .0975

 9.75% Cost , including flotation  $5,000,000 1 .0975

 $ 5 , 000 , 000 .

9025  $ 5 , 540 , 166 (rounded to whole dollars)

Chapter

15

End of Chapter 15

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.