Chap14 Pbms MBF12e - Problem 14.1 Trident's Cost of Capital...

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Problem 14.1 Trident's Cost of Capital a. Trident's cost of equity b. Trident's cost of debt c. Trident's weighted average cost of capital Values used Original assumptions in Chapter in Chapter New Values 1.20 1.30 Cost of debt, before tax, kd 8.00% 7.000% Risk-free rate of interest, krf 5.00% 4.000% Corporate income tax rate, t 35.00% 30.000% General return on market portfolio, km 15.00% 9.000% Optimal capital structure: Proportion of debt, D/V 40% 50% Proportion of equity, E/V 60% 50% a) Trident's cost of equity 17.000% 10.500% b) Trident's cost of debt, after tax 5.200% 4.900% kd x ( 1 - t ) c) Trident's weighted average cost of capital 12.2800% 7.7000% WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ] Exhibit 14.2 showed the calculation of Trident’s weighted average cost of capital. Assuming that financial conditions have worsened, and using the following current data, recalculate: Trident's beta, β ke = krf + ( km - krf ) β One of the most interesting aspects of capital costs is how they have been trending downward in recent years as a result of lower interest rates, lower equity market returns, and in some countries, lower tax rates. As a result of the general decline in business and economic performance, many firms have been reducing their debt levels -- if possible -- in order to reduce their debt service requirements. But, one factor which has not necessarily fallen in value is the beta of the individaul firm. Here Trident's cost of capital has fallen dramatically, but its beta is actually higher than before due to more market volatility.
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Problem 14.2 Curacao Pharmaceuticals a. If Curacao’s beta is estimated at 1.1, what is its weighted average cost of capital? Assumptions a) Values b) Values Curacao's beta 1.10 0.80 Cost of debt, before tax 7.000% 7.000% Risk-free rate of interest 3.000% 3.000% Corporate income tax rate 25.000% 25.000% General return on market portfolio 8.000% 8.000% Optimal capital structure: Proportion of debt, D/V 60% 60% Proportion of equity, E/V 40% 40% Calculation of the WACC Cost of debt, after-tax 5.250% 5.250% kd x ( 1 - t ) Cost of equity, after-tax 8.500% 7.000% WACC 6.550% 5.950% WACC = [ ke x E/V ] + [ ( kd x ( 1 - t ) ) x D/V ] Curacao Pharmaceutical’s cost of debt is 7%. The risk-free rate of interest is 3%. The expected return on the market portfolio is 8%. After effective taxes, Curacao’s effective tax rate is 25%. Its optimal capital structure is 60% debt and 40% equity. b. If Curacao’s beta is estimated at 0.8, significantly lower because of the continuing profit prospects in the global energy sector, what is its weighted average cost of capital? ke = krf + ( km - krf ) β
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Problem 14.3 Deming Pipelines, Inc. Assumptions
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This note was uploaded on 03/10/2012 for the course ACCOUNTING 5450 taught by Professor Brown during the Spring '12 term at Colorado Technical University.

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Chap14 Pbms MBF12e - Problem 14.1 Trident's Cost of Capital...

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