Midland Energy Resource Report for Cost of Capital October 16, 2014 Abstraction General Analysis of Midland Energy Resources Cost of Debt • • • • Consolidated Company Exploration & Production Refining and Marketing Petrochemicals Cost of Equity Equity market risk premium of 5% is reasonable. According to the Exhibit 6, the U.S. stock return minus Treasury bond yields for each period varies. Since each period has different standard error, it will be better to take the weighted average of the
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$10 Equity $90 Question 3a. What is the firm’s weighted cost of capital at various combinations of debt and equity, given the following information? Debts/Assets After Tax Debt Cost Cost of Equity Cost of Capital (weight)(cost of debt) weight (cost of equity) = k (cost of capital) 0% 8% 12% 10 8 12% 20 8 12% 30 8 13% 40 9 14% 50 10 15% 60 12 16% Answer – Debts/Assets After Tax Debt Cost Cost of Equity Cost of Capital (weight)(cost of debt) weight (cost of equity)
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ILLUSTRATION 1 COMPUTE THE COST FOR THE FOLLOWING: a. A bond that has a Rs 1,000 par value (face value) and coupon interest rate of 12 percent. A new issue would have a flotation cost of 5 percent of the Rs 1,100 market value. The bonds mature in 10 years The firm's average tax rate is 25 percent and its marginal tax rate is 30 percent. b. A preferred stock paying a 9 percent dividend on a Rs 100 par value. If a new issue is offered, flotation costs will be 5 percent of the
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Damodaran 1 The fundamental question: Does the mix of debt and equity affect the value of a business? Assets Existing Investments Generate cashflows today Includes long lived (fixed) and short-lived(working capital) assets Expected Value that will be created by future investments Assets in Place Debt Liabilities Fixed Claim on cash flows Little or No role in management Fixed Maturity Tax Deductible Growth Assets Equity Residual Claim on cash flows Significant Role in management Perpetual
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hi-tech, or a brokerage company. Guillermo Furniture Analysis Guillermo Furniture store was dominant in its region in developing customize furniture. However, they are starting to lose money because of competition from overseas and rising labor cost. The company must make a decision on how to proceed in the future. To ease their decision process they can use the following: five steps as a project moves from idea to reality: 1. Generating ideas for capital budgeting projects 2. Reviewing existing
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Wal-Mart and Target WACC We computed the WACC for Wal-Mart and Target based on their most current financials. The weights of debt and equity were obtained from MorningStar.com. The risk free rate is the current rate for 30 year treasuries, and the cost of debt is the current 20 year rate on corporate bonds rated AA and A+. The tax rates were estimated by dividing the taxes paid from the operating income from Wal-Mart and Targets income statements. The market risk premium was obtained from the
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THE COST OF CAPITAL The investor-supplied items- debt, preferred stock, and common equity- are called capital components. Increases in assets must be financed by increases in these capital components. The cost of each component is called its component cost. For example, Allied can borrow money at 10%, so its component cost of debt is 10%. These costs are then combined to form a weighted average cost of capital, which is used in the capital budgeting process. rd interest rate on the firm’s
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of 3.2% per year indefinitely. The firm has a debt/equity ratio of 4.0, a cost of equity of 12%, and an after-tax cost of debt of 6%. The cost-saving proposal is related to the firm’s core business, so it is viewed as having the same risks as the overall firm. Under what circumstances should the firm take on the project? WACC = 7.20% PV of cash savings = $125,000,000 ? Thus, the firm should take on the project if the initial investment cost of the project is less than $125 million. 5. EOCQ
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Professor Lin Solution to Individual Assignment 8 (1) The cost of equity is calculated as follows. Whirlpool: ........................... IBM: ..................................... Target Stores: ...................... 3.5% + (2.27 x 5.0%) = 14.85% 3.5% + (0.78 x 5.0%) = 7.40% 3.5% + (1.20 x 5.0%) = 9.50% (2) We use the book value of the debt and the market value of the equity as the proxies for the intrinsic values of debt and equity, respectively. Whirlpool 2,597 46.7% 2,959 53.3% 5,556 100%
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the value of a firm is positively related to its debt level. Since interest payments are deductible, increasing debt reduces taxes and raises the value of the firm. 3) There are no costs of financial distress. In the real world, costs of financial distress can be substantial. Since stockholders eventually bear these costs, there are incentives for a firm to lower the amount of debt in its capital structure. This topic will be discussed in more detail in later chapters. 2. False. A reduction
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