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- CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 3. Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it. One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the companys home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firms WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?COST OF CAPITAL Coleman Technologies is considering a major expansion program that has been proposed by the companys information technology group. Before proceeding with the expansion, the company must estimate its cost of capital. Suppose you are an assistant to Jerry Lehman, the financial vice president. Your first task is to estimate Colemans cost of capital Lehman has provided you with the following data, which he believes may be relevant to your task. The firms tax rate is 25%. The current price of Colemans 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity, is 1.153.72. Coleman does not use short-term, interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firms 10%, 100.00 par value, quarterly dividend, perpetual preferred stock is 111.10. Colemans common stock is currently selling for 50.00 per share. Its last dividend (D0) was 4.19, and dividends are expected to grow at a constant annual rate of 5% in the foreseeable future. Colemans beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4%. Colemans target capital structure is 30% debt, 10% preferred stock, and 60% common equity. To structure the task somewhat, Lehman has asked you to answer the following questions: a. 1. What sources of capital should be included when you estimate Colemans WACC? 2. Should the component costs be figured on a before-tax or an a after-tax basis? 3. Should the costs be historical (embedded) costs or new (marginal) costs? b. What is the market interest rate on Colemans debt and its component cost of debt? c. 1. What is the firms cost of preferred stock? 2. Colemans preferred stock is riskier to investors than its debt, yet the preferreds yield to investors is lower than the yield to maturity on the debt Does this suggest that you have made a mistake? (Hint: Think about taxes) d. 1. Why is there a cost associated with retained earnings? 2. What is Colemans estimated cost of common equity using the CAPM approach? e. What is the estimated cost of common equity using the DCF approach? f. What is the bond-yield-plus-risk-premium estimate for Colemans cost of common equity? g. What is your final estimate for rs? h. Explain in words why new common stock has a higher cost than retained earnings. i. 1. What are two approaches that can be used to adjust for flotation costs? 2. Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost? j. What is Colemans overall, or weighted average, cost of capital (WACC)? Ignore flotation costs. k. What factors influence Colemans composite WACC? l. Should the company use the composite WACC as the hurdle rate for each of its projects? Explain.Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 30% long-term debt, 15% preferred stock, and 55% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 22%. Debt The firm can sell for $1025 a 18-year, $1,000-par-value bond paying annual interest at a 8.00% coupon rate. A flotation cost of 4% of the par value is required. Preferred stock 10.00% (annual dividend) preferred stock having a par value of $100 can be sold for $92. An additional fee of $2 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $59.43 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.00 ten years ago to the $3.26 dividend payment, Do, that the company just recently…
- Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 30% long-term debt, 15% preferred stock, and 55% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 22%. Debt The firm can sell for $1015 a 10-year, $1,000-par-value bond paying annual interest at a 8.00% coupon rate. A flotation cost of 2% of the par value is required. Preferred stock 8.50% (annual dividend) preferred stock having a par value of $100 can be sold for $96. An additional fee of $4 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $60 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.70 ten years ago to the $5.07 dividend payment,…Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 50% long-term debt, 15% preferred stock, and 35% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 29%. Debt The firm can sell for $1015 a 20-year, $1,000-par-value bond paying annual interest at a 6.00% coupon rate. A flotation cost of 2% of the par value is required. Preferred stock 9.50% (annual dividend) preferred stock having a par value of $100 can be sold for $98. An additional fee of $2 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $90 per share. The stock has paid a dividend that has gradually increased for many years, rising from $3.00 ten years ago to the $5.63 dividend payment,…Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 50% long-term debt, 15% preferred stock, and 35% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 21%. Debt The firm can sell for $1030 a 17-year, $1,000-par-value bond paying annual interest at a 9.00% coupon rate. A flotation cost of 3% of the par value is required. Preferred stock 10.00% (annual dividend) preferred stock having a par value of $100 can be sold for $94. An additional fee of $6 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $50 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.50 ten years ago to the $3.70 dividend payment, Do, that the company just recently…
- Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 15% preferred stock, and 45% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 23%. Debt The firm can sell for $1010 a 14-year, $1,000-par-value bond paying annual interest at a 8.00% coupon rate. A flotation cost of 3.5% of the par value is required. Preferred stock 7.00% (annual dividend) preferred stock having a par value of $100 can be sold for $98. An additional fee of $4 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $80 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.50 ten years ago to the $4.92 dividend payment, D, that the company just recently…Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 35% long-term debt,15% preferred stock, and 50%common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 29%. Debt The firm can sell for $1000 a 15-year, $1,000-par-value bond paying annual interest at a 11.00%coupon rate. A flotation cost of 2.5% of the par value is required. Preferred stock 8.50% (annual dividend) preferred stock having a par value of $100 can be sold for $98.An additional fee of $3 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $90 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.70 ten years ago to the $4.84 dividend payment,…Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained earings, new common stock, or both). The firm's tax rate is 24%. Debt The firm can sell for $1000 a 11-year, $1,000-par-value bond paying annual interest at a 12.00% coupon rate. A flotation cost of 4% of the par value is required. Preferred stock 8.50% (annual dividend) preferred stock having a par value of $100 can be sold for $98. An additional fee of $3 per share must be paid to the underwriters. Common stock The firm's common stock is currently selling for $80 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.25 ten years ago to the $4.43 dividend payment, Do. that the company just recently…
- Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained eamings, new common stock, or both). The firm's tax rate is 21% Debt The firm can sell for $1020 a 10-year, $1,000-par-value bond paying annual interest at a 7.00% coupon rate: A flotation cost of 3% of the par value is required. Preferred stock 8.00% (annual dividend) preferred stock having a par value of $100 can be sold for $98. An additional fee of $2 per share must be paid to the underwriters Common stock The firm's common stock is currently selling for 559 43 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.70 ten years ago to the $4.00 dividend payment, Do, that the company just recently…Calculation of individual costs and WACC Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 40% long-term debt, 10% preferred stock, and 50% common stock equity (retained earnings, new common stock, or both). The firm’s tax rate is 40%.Debt The firm can sell for $980 a 10-year, $1,000-par-value bond paying annual interest at a 10% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of $20 per bond.Preferred stock Eight percent (annual dividend) preferred stock having a par value of $100 can be sold for $65. An additional fee of $2 per share must be paid to the underwriters.Common stock The firm’s common stock is currently selling for $50 per share. The dividend expected to be paid at the end of the coming year (2013) is $4. Its dividend payments, which have been approximately…Dillon Labs has asked its financial manager to measure the cost of each specific type of capital as well as the weighted average cost of capital. The weighted average cost is to be measured by using the following weights: 30% long-term debt, 10% preferred stock, and 60% common stock equity (retained earnings, new common stock, or both). The firm's tax rate is 23%. Debt : The firm can sell for $1030 a 14-year, $1,000-par-value bond paying annual interest at a 8.00% coupon rate. A flotation cost of 2% of the par value is required. Preferred stock: 9.00% (annual dividend) preferred stock having a par value of $100 can be sold for $92.An additional fee of $2 per share must be paid to the underwriters. Common stock: The firm's common stock is currently selling for $90 per share. The stock has paid a dividend that has gradually increased for many years, rising from $2.00 ten years ago to the $3.26 dividend payment, D0, that the company just recently made.…