Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 9, Problem 16SP
(Weighted average cost of capital) The capital structure for the Carion Corporation is provided here. The company plans to maintain its debt structure in the future. If the firm has a 5.5 percent after-tax cost of debt, a 13.5 percent cost of
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Ilumina Corp is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common stock. In order to estimate the cost of debt, the company has produced the following table:
Percent financed with debt (wd)
Percent financed with equity (wc)
Debt-to-equity ratio (D/S)
After-tax cost of debt (%)
0.25
0.75
0.25/0.75 = 0.33
6.9%
0.35
0.65
0.35/0.65 = 0.5385
7.1%
0.50
0.50
0.50/0.50 = 1.00
8.0%
The company uses the CAPM to estimate its cost of common equity, rs. The risk-free rate is 5% and the market risk premium is 6%. Ilumina estimates that its beta with 10% debt is 1. The company’s tax rate, T, is 40%. On the basis of this information, what is the company’s optimal capital structure, and what is the firm’s cost of capital at this optimal capital structure? (Please show work)
The calculation of WACC involves calculating the weighted average of the required rates of return on debt and equity, where the weights equal the
percentage of each type of financing in the firm's overall capital structure.
re
. has $3.9 million of debt, $1 million of preferred stock, and $1.2 million of common equity. What would be its weight on preferred stock?
Ip
Is
is the symbol that represents the before-tax cost of debt in the weighted average cost of capital (WACC) equation.
rd
0.13
0.64
0.16
0.14
The calculation of WACC involves calculating the weighted average of the required rates of return on debt, preferred stock, and common equity, where the weights equal the percentage of each type of financing in the firm’s overall capital structure.
is the symbol that represents the before-tax cost of debt in the weighted average cost of capital (WACC) equation.
Wyle Co. has $1.4 million of debt, $2.5 million of preferred stock, and $3.3 million of common equity. What would be its weight on debt?
0.28
0.32
0.19
0.46
Chapter 9 Solutions
Foundations Of Finance
Ch. 9 - Define the term cost of capital.Ch. 9 - Prob. 2RQCh. 9 - Why do firms calculate their weighted average cost...Ch. 9 - Prob. 4RQCh. 9 - Prob. 5RQCh. 9 - Prob. 6RQCh. 9 - Prob. 7RQCh. 9 - Prob. 1SPCh. 9 - Prob. 2SPCh. 9 - (Cost of equity) In the spring of 2018, the Brille...
Ch. 9 - Prob. 4SPCh. 9 - Prob. 5SPCh. 9 - Prob. 6SPCh. 9 - Prob. 7SPCh. 9 - (Cost of internal equity) Pathos Co.s common stock...Ch. 9 - (Cost of equity) The common stock for the Bestsold...Ch. 9 - Prob. 10SPCh. 9 - Prob. 11SPCh. 9 - Prob. 12SPCh. 9 - a. Rework Problem 9-12 as follows: Assume an 8...Ch. 9 - (Capital structure weights) Wingate Metal...Ch. 9 - (Weighted average cost of capital) The capital...Ch. 9 - Prob. 17SPCh. 9 - Prob. 18SPCh. 9 - Prob. 19SPCh. 9 - (Divisional costs of capital and investment...Ch. 9 - Prob. 21SPCh. 9 - Prob. 2.1MCCh. 9 - If you were to evaluate divisional costs of...
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- You are given the financial information for the Unic Company: Earnings Before Interest and Tax (EBIT) = $126.58 Corporate tax rate (TC) = 0.21 Debt (D) = $500 Unlevered cost of capital (RU) = 0.20 The cost of debt capital is 10 percent. Question: Determine the value of Unic Company equity? Determine the cost of equity capital for Unic Company? Determine the WACC for Unic Company?arrow_forwardAnalyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 25%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.) O 0.65% 0.81% O 0.55% O 0.85% Turnbull Co. is considering a project that requires an initial investment of $1,708,000. The…arrow_forwardAnalyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 45% debt, 4% preferred stock, and 51% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%. If its rent ta rate is 25%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your intermediate calculations to two decimal places.) 1.39% 1.34% 1.07% 0.96%arrow_forward
- Aaron Athletics is trying to determine its optimal capital structure. The company’s capital structure consists of debt and common equity. In order to estimate the cost of capital at various debt levels the company has constructed the following table: Percent financed with debt (wD) Percent financed with equity (ws) Before tax cost of debt 0.10 0.90 7.0% 0.20 0.80 7.2% 0.30 0.70 8.0% 0.40 0.60 8.8% 0.50 0.50 9.6% The company uses the CAPM to estimate its cost of equity, rS . The risk-free rate is 4% and the market risk premium is 5%. Aaron estimates that if it had no debt its beta would be 1.0. (It’s unlevered beta equals 1.0). The company’s tax rate is 40%. On the basis of this information, what is the company’s optimal capital structure, and what is the WACC at that capital structure? (Show your calculations at each debt level).arrow_forwardAssume that your company is trying to determine its optimal capital structure, which consists only of debt and common stock. To estimate the cost of debt, the company has produced the following table: 09.86% 9.56% Percent Financed With Debt 10.16% 8.96% 9.26% 0.10 0.20 0.30 0.40 0.50 Percent Financed With Equity 0.90 0.80 0.70 0.60 0.50 Debt/Equity Ratio Now assume that the company's tax rate is 40 percent, that the company uses the CAPM to estimate its cost of common equity, Ks, that the risk-free rate is 5 percent and the market risk premium is 6 percent. Finally assume that if it has no debt its WACC would be equal to its cost of equity which would be equal to 11 percent (you should now be able to determine its "unlevered beta," bu). 0.10/0.90 0.11 0.20/0.80 0.25 Given this information, determine the firm's cost of capital if it finances with 40 percent debt and 60 percent equity. 0.30/0.70=0.43 0.40/0.600.67 0.50/0.50 = 1.00 Bond Rating AA A A BB B Before-Tax Cost of Debt 7.0% 7.2%…arrow_forward8.4 Richmond Clinic has obtained the following estimates for its costs of debt and equity at various capital structures: Debt (%) After-Tax Cost of Debt (%) Cost of Equity (%) 0 — 16.0 20 6.6 17.0 40 7.8 19.0 60 10.2 22.0 80 14.0 27.0 What is the firm’s optimal capital structure? (Hint: Calculate its corporate cost of capital at each structure. Also, note that data on component costs at alternative capital structures are not reliable in real-world situations)arrow_forward
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