a. Calculate Enviro’s current after-tax cost of long-term debt. b. Calculate Enviro’s current cost of preferred stock. c. Calculate Enviro’s current cost of common stock.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Integrative Case 4 Enviro Plastics Company
Since its inception, Enviro Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Enviro’s founder, Marion Cosby, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for six years, Enviro went public in 2015 and is listed on the Nasdaq stock exchange.
As the chief financial officer of a young company with lots of investment opportunities, Enviro’s CFO closely monitors the firm’s cost of capital. The CFO keeps tabs on each of the individual costs of Enviro’s three main financing sources: long-term debt,
At the present time, Enviro can raise debt by selling 20-year bonds with a $1,000 par value and a 10.5% annual coupon interest rate. Enviro’s corporate tax rate is 21%, and its bonds generally require an average discount of $45 per bond and flotation costs of $32 per bond when being sold. Enviro’s outstanding preferred stock pays a 9% dividend and has a $95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Enviro is a young firm that requires lots of cash to grow, it does not currently pay a dividend to common stockholders. To track the cost of common stock, the CFO uses the
Although Enviro’s current target capital structure includes 20% preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long-term debt and 50% common stock. If Enviro shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5.
To Do
a. Calculate Enviro’s current after-tax cost of long-term debt.
b. Calculate Enviro’s current cost of preferred stock.
c. Calculate Enviro’s current cost of common stock.
d. Calculate Enviro’s current weighted average cost capital (WACC).
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 4 images
