Chapter 910 The Cost of Capital ANSWERS TO END-OF-CHAPTER QUESTIONS 910-1 a. The weighted average cost of capital, WACC, is the weighted average of the after-tax component costs of capital—-debt, preferred stock, and common equity. Each weighting factor is the proportion of that type of capital in the optimal, or target, capital structure. The after-tax cost of debt, rd(1 - T), is the relevant cost to the firm of new debt financing. Since interest is deductible from taxable income
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PROBLEM: COST OF CAPITAL 1. Cost of debt: ki = 9%(1 - 0.4) = 5.4% for the first $50 million ki = 10%(1 - 0.4) = 6% for debt exceeding $50 million. Cost of equity: (g = 7.2% using the Rule of 72) ke = $1.415/$21 + .072 = .139 or 13.9% for internal equity ke' = $1.415/$19 + .072 = .146 or 14.6% for external equity 2. Size of first interval: $50 million first mortgage bonds/0.40 = $125 million. (Balance of first block of funds is retained earnings with a cost of 13
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also identifying the associated risks and how those could be minimized. Assuming the development costs are correctly estimated and the market response is properly gauged, the reasons to go forward with the project outweigh those against it. The market competition corroborated with the unfavorable economic conditions prompt a swift and decisive answer from Boeing. The new 7E7 will have lower operating costs due to increased cargo space and increased fuel economy due to new engine design, would also
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calculation of Acid Test Ratio, Inventory is included in current assets. (xi) Working Capital Turnover Ratio may be classified as an Activity Ratio. (xii) Debt-Equity Ratio is a measure of long-term solvency of a firm. (xiii) GP Ratio and NP Ratio give the profitability of the firm from the point of view of the shareholders. (xiv) Return on Equity and Earnings per Share are one and the same thing. (xv) DU PONT Analysis looks into the elements of profits. (xvi) Ratio Analysis provides the solution to
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WACC or Weighted Average Cost of Capital: Summary “Cheat Sheet” by MBAbullshit.com Money (capital) needed to run a company comes from either borrowing (debt) or the owners’ money (equity). The COST of capital is either the interest payment on the debt, or the required profit that the owners want in return for their investment (in MBA bullshit language: “expected return”). The expected return or COST OF EQUITY is determined by another financial model, the CAPM or the CAPITAL ASSET PRICING MODEL
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following questions: 1. What does it mean when people refer to a firm’s “cost of capital?” 2. What are the three components that normally make up a firm’s weighted average cost of capital (WACC)? 3. (calculating the after-tax cost of debt) Suppose your firm can borrow what it needs from a local bank at 4.5% interest. If your firm’s effective tax rate is 40%, what is its after-tax cost of debt? 4. (calculating the cost of preferred stock) Suppose your firm wants to finance a project, in part
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likely explain the difference between Microsoft's market value of equity and its reported book value of equity? Microsoft's market value of equity is notably different from its reported book value of equity for two aspects of reasons. First of all, Microsoft's software capitalization policy and revenue recognition policy make it have a lower reported book value of equity. Microsoft expensed all incurred research and development costs in which some should have been capitalized. This accounting treatment
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talent in the event of financial distress costs will exceed any tax benefit by $20 million. At the same time, because investors believe that managers know the correct share, IST faces a lemons problem if it attempts to raise the $500 million by issuing equity. a. Suppose that if IST issues equity, the share price will remain $13.50. To maximize the long term share price of the firm once its true value is known, would managers choose to issue equity or borrow the $500 million if i
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significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Often, the assets of the company being acquired are used as collateral for the loans in addition to the assets of the acquiring company. The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital. | | In an LBO, there is usually a ratio of 90% debt to 10% equity. Because of this high debt/equity ratio, the bonds usually are not investment grade and are
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Case Analysis of Nike, Inc.: Cost of Capital (CON) Cost of Equity The cost of equity is comprised the cost of preferred stock and common stock. In this case, I am willing to focus on the cost of common stock because Nike did not pay any dividend after June 30, 2001(see Exhibit 4). The cost of common stock is the return needed on the stock by shareholders in which investors discount the expected dividends of the firm to ascertain its share price. To perceive this definition, let me bring
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