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.
Find the net proceeds from the sale of each bond for Warren Industries.
Calculate the before-tax and the after-tax cost of debt for Warren Industries.
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
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 Po = $97.50). Finally, flotation costs of $2.50 must be paid for
each new share Gem Systems issues.
Calculate the cost of preferred stock based on the outstanding issue, given the current
market price.
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?
Calculate the cost of preferred stock (rPS) for each of the following:
Preferred Stock
Par Value
Current Price (Po)
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%
JPM Corporation common stock has a beta of 1.2. The risk-free rate is 6%, and the market
return is 11%.
Derive the risk premium on JPM common stock.
Determine JPMs cost of common equity using the CAPM.
Reynolds Textiles wants to measure its cost of common equity. The firms 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
D1 = $3.40 for purposes of calculation). The dividends for the last 5 years are as
follows:
Year
Dividend
2010
2009
2008
2007
2006
$3.10
$2.92
$2.60
$2.30
$2.12
After incurring flotation costs, Reynolds Textiles expects to net $52 per share on a new
issue.
Determine the growth rate of dividends (g).
By applying the constant-growth valuation model, determine the cost of retained earnings
common equity (rs).
By applying the constant-growth valuation model, determine the cost of newly-issued
common equity (re).
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., rs = 14%), the cost of preferred stock financing is 9% (rps = 9%), and
the before-tax cost of debt is 11% (rd = 11%). Calculate the weighted average cost of capital
(WACC) given the tax rate assumptions in parts (a) to (c) below.
Tax rate = 40%.
Tax rate = 35%.
Tax rate = 25%.
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
Calculate the firms weighted average cost of capital (WACC) using book value weights.
Calculate the firms weighted average cost of capital (WACC) using market value weights.
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?
To help finance a major expansion, Delano Development Company sold a noncallable
bond several years ago that now has 15 years to maturity. This bond has a 10.25% annual
coupon, paid semiannually, it sells at a price of $1,025, and it has a par value of $1,000. If
Delanos tax rate is 40%, what component cost of debt should be used in the WACC
calculation?
Roxie Epoxys balance sheet shows a total of $50 million long-term debt with a coupon
rate of 8.00% and a yield to maturity of 7.00%. This debt currently has a market value of
$55 million. The balance sheet also shows that that the company has 20 million shares of
common stock, and the book value of the common equity (common stock plus retained
earnings) is $65 million. The current stock price is $8.25 per share; stockholders' required
return, rs, is 10.00%; and the firm's tax rate is 40%. Based on market value weights, and
assuming the firm is currently at its target capital structure, what WACC should Roxie
use to evaluate capital budgeting projects?
Bruner Breakfast Foods (BBF) balance sheet shows a total of $20 million long-term debt
with a coupon rate of 8.00% (assume each bond to have a maturity value, M, of $1,000).
The yield to maturity on this debt is 10.00%, and the debt has a total current market value
of $18 million. The balance sheet also shows that that the company has 10 million shares
of stock, and total of common equity (common stock plus retained earnings) is $30
million. The current stock price is $4.50 per share, and stockholders' required rate of
return, rs, is 12.25%. The company recently decided that its target capital structure should
have 50% debt, with the balance being common equity. The tax rate is 40%. Calculate
WACCs based on target, book, and market value capital structures (Note: I am asking for
three (3) separate WACC values here).