After discussions with an investment banker about issuing additional debt, your analyst found that the cost of debt (before tax) depends on the amount of debt in the capital structure. Cost of debt estimates for various levels of debt financing (D/E) were obtained and the firm's analysts have partially prepared information for the company's cost of capital at various levels of debt and equity: E/A (Wee) D/A D/E (W) ra ra(1-T) b re WACC 0.000 0.00% 0.00% 0.91 1.000 5.02% 5.022% 0.50 2.05% 1.22 0.411 2.55% 1.00 3.75% 5.068% Where: ra = before tax cost of debt, o ra(1-T) = after tax cost of debt, b = beta, rs = cost of common equity, o Wa = Weight of debt, o Wce = Weight of common equity, KEMPER uses the firm's WACC for average-risk projects, and it adds 2% for high-risk projects. For low-risk projects, it uses the WACC less 2%. Management utilizes risk-adjusted hurdle rates for evaluating capital budgeting projects. All potential projects are classified using a five-level classification system: Hurdle Rate WACC - 2 Risk Level Class A Low risk Below average risk WACC - 1 Equal to the WACC WACC + 1 C Normal risk Above average risk High risk E WACC + 2 KEMPER considers the proposed project to be a high-risk project. Given all of the information provided in this case: (Show your work, calculations, and explain your answers well) Cost of Capital, Capital Structure, Hurdle Rate: What is the firm's current Weighted Average Cost of Capital (WACC) at its current capital structure? • Capital Structure theory addresses finding a firm's optimal capital structure. How do you determine the optimal capital structure? What is the company's optimal capital structure? (First, complete the Cost of Capital & Capital Structure worksheet)
Cost of Debt, Cost of Preferred Stock
This article deals with the estimation of the value of capital and its components. we'll find out how to estimate the value of debt, the value of preferred shares , and therefore the cost of common shares . we will also determine the way to compute the load of every cost of the capital component then they're going to estimate the general cost of capital. The cost of capital refers to the return rate that an organization gives to its investors. If an organization doesn’t provide enough return, economic process will decrease the costs of their stock and bonds to revive the balance. A firm’s long-run and short-run financial decisions are linked to every other by the assistance of the firm’s cost of capital.
Cost of Common Stock
Common stock is a type of security/instrument issued to Equity shareholders of the Company. These are commonly known as equity shares in India. It is also called ‘Common equity
![After discussions with an investment banker about issuing additional debt, your analyst
found that the cost of debt (before tax) depends on the amount of debt in the capital
structure. Cost of debt estimates for various levels of debt financing (D/E) were obtained
and the firm's analysts have partially prepared information for the company's cost of
capital at various levels of debt and equity:
DIA
E/A
D/E
(W.)
ra
ra(1-T)
(Wco)
re
WACC
0.000
0.00%
0.00%
0.91
1.000
5.02%
5.022%
0.50
2.05%
1.22
0.411
2.55%
1.00
3.75%
5.068%
Where:
ra = before tax cost of debt,
o ra(1-T) = after tax cost of debt,
b = beta,
rs = cost of common equity,
Wa = Weight of debt,
Wce = Weight of common equity,
%3D
KEMPER uses the firm's WACC for average-risk projects, and it adds 2% for high-risk
projects. For low-risk projects, it uses the WACC less 2%.
Management utilizes risk-adjusted hurdle rates for evaluating capital budgeting projects.
All potential projects are classified using a five-level classification system:
Risk Level
Class
Hurdle Rate
Low risk
Below average risk
Normal risk
A
WACC – 2
WACC – 1
Equal to the WACC
WACC + 1
В
C
Above average risk
High risk
D
E
WACC + 2
KEMPER considers the proposed project to be a high-risk project.
Given all of the information provided in this case:
(Show your work, calculations, and explain your answers well)
Cost of Capital, Capital Structure, Hurdle Rate:
What is the firm's current Weighted Average Cost of Capital (WACC) at its current
capital structure?
• Capital Structure theory addresses finding a firm's optimal capital structure. How do you
determine the optimal capital structure?
• What is the company's optimal capital structure? (First, complete the Cost of Capital &
Capital Structure worksheet)](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa0a43d2b-9546-4d41-a578-d063425f347b%2Fec29e041-783a-4c7c-bf87-76f49982a546%2Fdup9tkr_processed.jpeg&w=3840&q=75)
![B.E. Kemper, LLC (KEMPER) is a custom parts fabricator supporting the classic auto and
recreational marine industries.
The company is evaluating a proposal by its Marketing department to develop one-of-a-kind,
customize parts for resto-mod professionals and the hobbyist in their desire for that special,
unique "new" old car/truck. This approach will require the expertise of design artists and
engineers working with the restorer and the need for custom programs, computer-aided design,
CNC milling equipment, and both polymer & metal 3D printing equipment
Market studies indicate that the restoration market is continuing to grow and is broadening to
include the newer 'classic' vehicles of the '80s and '90s. The industry consists of both
professional restoration shops and many talented hobbyists. The anticipated demand is
incorporated in the forecasts below.
Sales Forecast:
The estimate of sales revenues for this project is $1,250,000 in year 1. Sales growth of
50% is forecast for year 2, 30% for year 3, then the growth rate settles to 10% each year
for years 4, 5 and 6. Sales are then stable with a growth rate of 0% (equal to year 6) in
years 7 and 8. Finally, sales are expected to decline by 10% in year 9.
Production cost forecasts are:
Fixed costs: $455,000 per year (a large portion of this cost is labor for the
designer and engineer).
o Annual variable costs: 46% of sales revenue.
The company will have to purchase new equipment, mentioned above, to produce the
new product. The equipment, including shipping and installation, is expected to cost
(t=0) $ 5,325,000.
• The equipment falls into the IRS 10-year class life using the MACRS depreciation
method with the ½ year convention. (See MACRS table).
• If the company goes ahead with the proposed product, it will affect the company's net
operating working capital. At the outset, t = 0, inventory will increase by $265,000.
Accounts receivable will increase by $125,000, and accounts payable will increase by
$245,000.
The net operating working capital will be liquidated after the project is completed.
The program (project) is planned to continue for 9 years. At the end of the project, the
equipment will be salvaged (sold). The forecasts predict that the equipment can be sold
then for $225,500.
Current Capital Structure
KEMPER has the following levels of debt and common equity (market values):
o Debt:
o Equity:
o Total Capital: $11,916,000
$ 4,894,300
$ 7.021,700
The company has a marginal (federal + state) tax rate (T) of 31%, and uses MACRS
depreciation.
MACRS (half-year convention incorporated)
Depreciation (% of depreciable basis)
Class - life
10-
Year
20.00% 14.29% | 10.00%
32.00% | 24.49% | 18.00%
Year of Operation
3-Year
5-Year
7-Year
1
33.33%
44.45%
14.81%
19.20%
17.49%
14.40%
4
7.41%
11.52%
12.49%
11.52%
11.52%
8.93%
9.22%
5.76%
8.92%
7.37%
7
8.93%
6.55%
4.46%
6.55%
9.
6.56%
6.55%
10
11
3.28%
Your analysts compiled current market information:
o Market risk premium (rm – rH): 4.25%
Risk-free rate (rn):
1.14%
The company's beta (at its current capital structure) is: 1.34](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fa0a43d2b-9546-4d41-a578-d063425f347b%2Fec29e041-783a-4c7c-bf87-76f49982a546%2F6we95pk_processed.jpeg&w=3840&q=75)
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