Tut07q - July 2009 Strictly for course AB102 (2009)...

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July 2009 Strictly for course AB102 (2009) internal circulation only. Nanyang Business School AB102 Financial Management Tutorial 7: The Cost of Capital (Common Questions) 1) (10-9) WACC . The Patrick Company’s cost of common equity is 16 percent, its before-tax cost of debt is 13 percent, and its marginal tax rate is 40 percent. The stock sells at book value. Using the following balance sheet, calculate Patrick’s WACC: Assets Liabilities and Equity Cash $120 Accounts receivable 240 Inventories 360 Long-term debt $1,152 Plant and equipment, net 2,160 Equity 1,728 Total assets $2,880 Total liabilities and equity $2,880 2) (10-10) WACC . Klose Outfitters Inc. believes that its optimal capital structure consists of 60 percent common equity and 40 percent debt, and its tax rate is 40 percent. Klose must raise additional capital to fund its upcoming expansion. The firm will have $2 million of new retained earnings that with a cost of r s = 12%. New common stock in an amount up to $6 million would have a cost of r e = 15%. Furthermore, Klose can raise up to $3 million of debt at an interest rate of r d = 10%, and an additional $4 million of debt at r d = 12%. The CFO estimates that a proposed expansion would require an investment of $5.9 million. What is the WACC for the last dollar raised to complete the expansion? 3) (10-19) Adjusting cost of capital for risk . Ziege Systems is considering the following independent projects for the coming year. PROJECT REQUIRED INVESTMENT RATE OF RETURN RISK A $4 million 14.0% High B 5 million 11.5 High C 3 million 9.5 Low D 2 million 9.0 Average E 6 million 12.5 High F 5 million 12.5 Average G 6 million 7.0 Low H 3 million 11.5 Low Ziege’s WACC is 10 percent, but it adjusts for risk by adding 2 percent to the WACC for high- risk projects and subtracting 2 percent for low-risk projects. a) Which projects should Ziege accept if it faces no capital constraints?
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This note was uploaded on 01/23/2011 for the course SSDWW 2324 taught by Professor Dfsf during the Spring '10 term at Nanzan.

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Tut07q - July 2009 Strictly for course AB102 (2009)...

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