Bob-Bye, Inc. 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 WACC 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 is 30%. Debt: The firm can sell for P980, a 10-year, P1,000 par value bond paying annual interest at a 13% coupon rate. A flotation cost of 3% of the par value is required in addition to the discount of P20 per bond. Preferred Stock: 8 percent (annual divided) preferred stock having a par value of P100 can be sold for P65. An additional fee of P2 per share must be paid to the underwriters. Common Stock: The firm’s common stock is currently selling for P50 per share. The dividend expected to be paid at the end of the coming year is P4 per share.. Its dividend payments which have been approximately 60% of earnings per share in each of the past 5 years, shown below has an average growth rate of 7.5% annually. Year Dividend Year Dividend 2019 P 3.75 2016 P3.15 2018 3.50 2015 2.85 2017 3.30 It is expected that to attract buyers, new common stock must be under-priced P5 per share, and the firm must also pay P3 per share in flotation costs. Dividend payments are expected to continue at 60% earnings. Required: Compute the weighted average cost of capital (WACC) assuming retained earnings is sufficient to cover the equity portion of fund Compute the average cost of capital (WACC) assuming retained earnings is not sufficient to cover the equity portion, so new issue common stock should be issued.
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.
Problem 1 - Cost of Capital
Bob-Bye, Inc. has asked its
Debt: The firm can sell for P980, a 10-year, P1,000 par
Preferred Stock: 8 percent (annual divided) preferred stock having a par value of P100 can be sold for P65. An additional fee of P2 per share must be paid to the underwriters.
Common Stock: The firm’s common stock is currently selling for P50 per share. The dividend expected to be paid at the end of the coming year is P4 per share..
Its dividend payments which have been approximately 60% of earnings per share in each of the past 5 years, shown below has an average growth rate of 7.5%
annually.
|
Year |
Dividend |
Year |
Dividend |
|
2019 |
P 3.75 |
2016 |
P3.15 |
|
2018 |
3.50 |
2015 |
2.85 |
|
2017 |
3.30 |
|
|
It is expected that to attract buyers, new common stock must be under-priced P5 per share, and the firm must also pay P3 per share in flotation costs.
Dividend payments are expected to continue at 60% earnings.
Required:
- Compute the weighted average cost of capital (WACC) assuming retained earnings is sufficient to cover the equity portion of fund
- Compute the average cost of capital (WACC) assuming retained earnings is not sufficient to cover the equity portion, so new issue common stock should be issued.
Trending now
This is a popular solution!
Step by step
Solved in 2 steps with 2 images
