If
you use Excel to calculate some portions of this assignment (which is fine), be
sure the final report is printable and readable in standard format
(i.e., on an 8.5 x 11 page). Please print out your Excel file (in its exact
form) prior to sending it to be sure it is well organized, formatted properly,
and doesn’t print out with multiple blank pages or separated columns .
1.
At
the current time Warren Industries can issue 15-year, $1,000 par-value bonds
paying annual interest at a 12% coupon rate. As a result of current interest
rates, the bonds can be sold for $1,010 each. Flotation costs of $30 per bond
will be incurred in the process (which implies that f = 2.97%, or 0.0297 in
decimal form) and the firm is in a 40% tax bracket.
(a)
Find
the net proceeds from the sale of each bond for Warren Industries.
(b)
Calculate
the before-tax and the after-tax cost of debt for Warren
Industries.
2.
Drywall
Systems, Inc., is presently in discussions with its investment bankers
regarding the issuance of new bonds. The investment banker has informed the
company that different maturities will carry different coupon rates and sell at
different prices. Drywall Systems 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. This implies that the firm will net $970 per bond, before
the adjustment for the premium (+) or discount (-). The company is taxed at a
rate of 40%. Calculate the after-tax costs of financing with each of the
following alternatives.
Alternative |
Coupon Rate |
Time to Maturity |
Premium (+) or Discount (-) |
A |
9% |
16 years |
+ $250 |
B |
7% |
5 years |
+ $50 |
C |
6% |
7 years |
Par |
D |
5% |
10 years |
– $75 |
3. Gem
Systems has recently issued preferred stock. The stock has a 12% annual
dividend based on a par value of $100 per share. The stock is currently selling
for $97.50 per share in the secondary market (so that P_{o} = $97.50). Finally,
flotation costs of $2.50 must be paid for each new share Gem Systems issues.
(a) Calculate
the cost of preferred stock based on the outstanding issue, given the current
market price.
(b) If
Gem Systems sells a new issue of preferred stock carrying a par value of $100
but with an annual dividend of 10% of par, what is the cost of this newly
issued preferred stock if the firm nets $90.00 per share after flotation costs?
4. Calculate
the cost of preferred stock (r_{PS}) for each of the following:
Preferred Stock |
Par Value |
Current Price (P_{o}) |
Flotation Cost |
Annual Dividend (% of Par) |
A |
$100 |
$101 |
$9.00 |
11% |
B |
$40 |
$38 |
$3.50 |
8% |
C |
$35 |
$37 |
$4.00 |
$5.00 |
D |
$30 |
$26 |
5% of par |
$3.00 |
E |
$20 |
$20 |
$2.50 |
9% |
5. JPM
Corporation common stock has a beta of 1.2. The risk-free rate is 6%, and the
market return is 11%.
(a) Derive
the risk premium on JPM common stock.
(b) Determine
JPM’s cost of common equity using the CAPM.
6. Reynolds
Textiles wants to measure its cost of common equity. The firm’s stock is
currently selling for $57.50 per share. The firm expects to pay a $3.40
dividend at the end of 2011 (so assume that
D_{1} = $3.40 for purposes
of calculation). The dividends for the last 5 years are as follows:
Year Dividend
2010 $3.10
2009 $2.92
2008 $2.60
2007 $2.30
2006 $2.12
After
incurring flotation costs, Reynolds Textiles expects to net $52 per share on a
new issue.
(a) Determine
the growth rate of dividends (g).
(b) By
applying the constant-growth valuation model, determine the cost of retained
earnings common equity (r_{s}).
(c) By
applying the constant-growth valuation model, determine the cost of
newly-issued common equity (r_{e}).
7. Brite
Lighting Corporation wants to investigate the effect on its cost of capital
based on the rate at which the company is taxed. The firm wishes to maintain a
capital structure of 30% debt, 10% preferred stock, and 60% common stock. The
cost of financing with retained earnings is 14% (i.e., r_{s} = 14%),
the cost of preferred stock financing is 9% (r_{ps} = 9%), and the before-tax
cost of debt is 11% (r_{d} = 11%). Calculate the weighted average cost
of capital (WACC) given the tax rate assumptions in parts (a) to (c) below.
(a) Tax
rate = 40%.
(b) Tax
rate = 35%.
(c) Tax
rate = 25%.
8. Westerly
Manufacturing has compiled the information shown in the following table:
Source of Capital |
Book Value |
Market Value |
After-tax Cost |
Long-Term Debt |
$4,000,000 |
$3,840,000 |
6.0% |
Preferred Stock |
$40,000 |
$60,000 |
13.0% |
Common Stock Equity |
$1,060,000 |
$3,000,000 |
17.0% |
Totals |
$5,100,000 |
$6,900,000 |
(a) Calculate
the firm’s weighted average cost of capital (WACC) using book value weights.
(b) Calculate
the firm’s weighted average cost of capital (WACC) using market value weights.
(c) Compare
your answers found in parts (a) and (b) and briefly explain the differences. Other
things equal, would you recommend that Westerly Manufacturing rely on its book
value weights or market value weights in determining its WACC?
9. |
10. |
11. |