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21. Given the following information, calculate the weighted average cost of capital for Hamilton Corp. Line up the calculations in the order shown in Table 11-1. Percent of capital structure: Debt.... Preferred stock.... 30% 15 Common equity.... 55 Additional information: Bond coupon rate..... Bond yield to maturity... Dividend, expected common..... Dividend, preferred.... Price, common. Price, preferred.... Flotation cost, preferred.. Growth rate... 13% 11% $3.00 $10.00 $50.00 $98.00 $5.50 8% 30% Corporate tax rate...

21. Given the following information, calculate the weighted average cost of capital for Hamilton Corp. Line up the calculations in the order shown in Table 11-1. Percent of capital structure: Debt.... Preferred stock.... 30% 15 Common equity.... 55 Additional information: Bond coupon rate..... Bond yield to maturity... Dividend, expected common..... Dividend, preferred.... Price, common. Price, preferred.... Flotation cost, preferred.. Growth rate... 13% 11% $3.00 $10.00 $50.00 $98.00 $5.50 8% 30% Corporate tax rate...

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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1:55 Search Aa 454 MBAD6110-A 342 Part 4 The Capital Budgeting Process financing a conveyor system having an 8 percent return with 6 percent debt and also evaluating a new product having an 11 percent return but financed with 12 percent com- mon stock. If projects and financing are matched in this way, the project with the lower return would be accepted and the project with the higher return would be rejected. In real- ity, if stock and debt are sold in equal proportions, the average cost of financing would be 9 percent (one-half debt at 6 percent and one-half stock at 12 percent). With a 9 percent average cost of financing, we would now reject the 8 percent conveyor system and accept the 11 percent new product. This would be a rational and consistent decision. Though an investment financed by low-cost debt might appear acceptable at first glance, the use of debt might increase the overall risk of the firm and eventually make all forms of financing more expensive. Each project must be measured against the overall cost of funds to the firm. We now consider cost of capital in a broader context. We can best understand how to determine the cost of capital by examining the capital structure of a hypothetical firm, the Baker Corporation, in Table 11-1. Note that the after- tax costs of the individual sources of financing are shown, then weights are assigned to each, and finally a weighted average cost is determined. (The costs under consideration are those related to new funds that can be used for future financing, rather than historical costs.) In the remainder of the chapter, each of these procedural steps is examined. Table 11-1 Cost of capital-Baker Corporation (1) (2) (3) Weighted Cost (aftertax) Weights Cost Debt ... Kd 7.05% 30% 2.12% Preferred stock Kp 10.94 10 1.09 Common equity (retained earnings) Ke 12.00 60 7.20 Weighted average cost of capital K. 10.41% Each element in the capital structure has an explicit, or opportunity, cost associated with it, herein referred to by the symbol K. These costs are directly related to the valu- ation concepts developed in the previous chapter. If we understand how a security is valued, then there is little problem in determining its cost. The mathematics involved in the cost of capital are not difficult. We begin our analysis with a consideration of the cost of debt. Cost of Debt The cost of debt is measured by the interest rate at which a company can raise new capital. For companies that do not issue bonds but simply borrow from a bank, this rate will be the rate at which they can borrow from the bank. The more interesting case arises when the cost of debt is measured by the interest rate, or yield, paid to bond- holders. The simplest case would be a $1,000 bond paying $100 annual interest, thus providing a 10 percent yield. The computation may be more difficult if the bond is Bookmark added 454 Reader Contents Notebook Bookmarks Flashcards IK
Transcribed Image Text:1:55 Search Aa 454 MBAD6110-A 342 Part 4 The Capital Budgeting Process financing a conveyor system having an 8 percent return with 6 percent debt and also evaluating a new product having an 11 percent return but financed with 12 percent com- mon stock. If projects and financing are matched in this way, the project with the lower return would be accepted and the project with the higher return would be rejected. In real- ity, if stock and debt are sold in equal proportions, the average cost of financing would be 9 percent (one-half debt at 6 percent and one-half stock at 12 percent). With a 9 percent average cost of financing, we would now reject the 8 percent conveyor system and accept the 11 percent new product. This would be a rational and consistent decision. Though an investment financed by low-cost debt might appear acceptable at first glance, the use of debt might increase the overall risk of the firm and eventually make all forms of financing more expensive. Each project must be measured against the overall cost of funds to the firm. We now consider cost of capital in a broader context. We can best understand how to determine the cost of capital by examining the capital structure of a hypothetical firm, the Baker Corporation, in Table 11-1. Note that the after- tax costs of the individual sources of financing are shown, then weights are assigned to each, and finally a weighted average cost is determined. (The costs under consideration are those related to new funds that can be used for future financing, rather than historical costs.) In the remainder of the chapter, each of these procedural steps is examined. Table 11-1 Cost of capital-Baker Corporation (1) (2) (3) Weighted Cost (aftertax) Weights Cost Debt ... Kd 7.05% 30% 2.12% Preferred stock Kp 10.94 10 1.09 Common equity (retained earnings) Ke 12.00 60 7.20 Weighted average cost of capital K. 10.41% Each element in the capital structure has an explicit, or opportunity, cost associated with it, herein referred to by the symbol K. These costs are directly related to the valu- ation concepts developed in the previous chapter. If we understand how a security is valued, then there is little problem in determining its cost. The mathematics involved in the cost of capital are not difficult. We begin our analysis with a consideration of the cost of debt. Cost of Debt The cost of debt is measured by the interest rate at which a company can raise new capital. For companies that do not issue bonds but simply borrow from a bank, this rate will be the rate at which they can borrow from the bank. The more interesting case arises when the cost of debt is measured by the interest rate, or yield, paid to bond- holders. The simplest case would be a $1,000 bond paying $100 annual interest, thus providing a 10 percent yield. The computation may be more difficult if the bond is Bookmark added 454 Reader Contents Notebook Bookmarks Flashcards IK
2:19 scribd.com = S SCRIBD Search Q Download Now 21. Given the following information, calculate the weighted average cost of capital for Hamilton Corp. Line up the calculations in the order shown in Table 11-1. Percent of capital structure: Debt... Preferred stock.. Common equity..... 30% 15 55 Additional information: Bond coupon rate..... Bond yield to maturity... Dividend, expected common.... Dividend, preferred.. Price, common. Price, preferred... Flotation cost, preferred... Growth rate... Corporate tax rate.. 13% 11% $3.00 $10.00 $50.00 $98.00 $5.50 8% 30% S11-18
Transcribed Image Text:2:19 scribd.com = S SCRIBD Search Q Download Now 21. Given the following information, calculate the weighted average cost of capital for Hamilton Corp. Line up the calculations in the order shown in Table 11-1. Percent of capital structure: Debt... Preferred stock.. Common equity..... 30% 15 55 Additional information: Bond coupon rate..... Bond yield to maturity... Dividend, expected common.... Dividend, preferred.. Price, common. Price, preferred... Flotation cost, preferred... Growth rate... Corporate tax rate.. 13% 11% $3.00 $10.00 $50.00 $98.00 $5.50 8% 30% S11-18
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