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Ch 09 Mini Case3/7/2003Chapter 9. Mini CaseSituation(1) The firm's tax rate is 40%To structure the task somewhat, Jones has asked you to answer the following questions.During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice-president. Your first task is to estimate Harry Davis' cost of capital. Jones has provided data that she believes is relevant to your task. (2) The current price of Harry Davis' 12 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation costs. (3) The current price of the firm's 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $113.10 Harry Davis would incur a flotation cost of $2.00 per share on a new issue.(4) Harry Davis' common stock is currently selling at $50 per share. Its last dividend (Do) was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Harry Davis' beta is 1.2, the yield on T-bonds is 7 percent, and the market risk premium is estimated to be 6 percent. For the bond-yield-risk-premium approach, the firm uses a 4 percentage point risk premium.(5) Harry Davis' target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60 percent common equity.a. (1.) What sources of capital should be included when you estimate Harry Davis' weighted average cost of capital (WACC)? b. What is the market interest rate on Harry Davis' debt and its component cost of debt?01230N30PV1,153.72 PMT60FV100010%PROBLEM10%Tax rate40%(1-Tax rate)x60%x10%6.0%During the last few years, Harry Davis Industries has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Leigh Jones, the financial vice-president. Your first task is to estimate Harry Davis' cost of capital. Jones has provided data that she believes is relevant to your task. (2) The current price of Harry Davis' 12 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Harry Davis does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation costs. (3) The current price of the firm's 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $113.10 Harry Davis would incur a flotation cost of $2.00 per share on a new issue.(4) Harry Davis' common stock is currently selling at $50 per share. Its last dividend (Do) was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Harry Davis' beta is 1.2, the yield on T-bonds is 7 percent, and the market risk premium is estimated to be 6 percent. For the bond-yield-risk-premium approach, the firm uses a 4 percentage point risk premium.(5) Harry Davis' target capital structure is 30 percent long-term debt, 10 percent preferred stock, and 60 percent common equity.a. (1.) What sources of capital should be included when you estimate Harry Davis' weighted average cost of capital (WACC)? Answer: See Chapter 9 Mini Case Show(2.) Should the component costs be figured on a before-tax or an after-tax basis? Answer: See Chapter 9 Mini Case Show(3.) Should the costs be historical (embedded) costs or new (marginal) costs? Answer: See Chapter 9 Mini Case ShowCOST OF DEBT, rdrd=
B-T rdA-T rd =(B-T rd)A-T rd =A-T rd =COST OF PREFERRED STOCK, rpABCDEFGHIJK12

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