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tax rate is 40%.

tax rate is 40%.

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
Problem 1PS
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GIVEN INFORMATION: In recent years, EVBOLT Industries has faced challenges due to the high cost of capital, limiting its ability to undertake significant capital investments. However, with a recent decline in capital costs, the company is now considering a substantial expansion program proposed by the marketing department. As an assistant to Leigh Jones, the financial vice president, your initial task is to estimate EVBOLT's cost of capital. Jones has provided relevant data for this task: (1) The firm's tax rate is 40%. (2) The current price of EVBOLT's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. The company does not use short-term interest-bearing debt on a permanent basis, and new bonds would be privately placed with no flotation cost. (3) The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Flotation costs equal to 5% of the proceeds would be incurred on a new issue. (4) EVBOLT's common stock is currently priced at $50 per share. Its last dividend (Do) was $3.12, and dividends are expected to grow at a constant rate of 5.8%. The company's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated at 6%. For the own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% risk premium. (5) EVBOLT's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. Questions h through k: h. What is EVBOLT's weighted average cost of capital (WACC)? i. What factors influence a company's WACC? j. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What are three types of project risk? How can each type of risk be considered when thinking about the new division's cost of capital?
Transcribed Image Text:GIVEN INFORMATION: In recent years, EVBOLT Industries has faced challenges due to the high cost of capital, limiting its ability to undertake significant capital investments. However, with a recent decline in capital costs, the company is now considering a substantial expansion program proposed by the marketing department. As an assistant to Leigh Jones, the financial vice president, your initial task is to estimate EVBOLT's cost of capital. Jones has provided relevant data for this task: (1) The firm's tax rate is 40%. (2) The current price of EVBOLT's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. The company does not use short-term interest-bearing debt on a permanent basis, and new bonds would be privately placed with no flotation cost. (3) The current price of the firm's 10%, $100 par value, quarterly dividend, perpetual preferred stock is $116.95. Flotation costs equal to 5% of the proceeds would be incurred on a new issue. (4) EVBOLT's common stock is currently priced at $50 per share. Its last dividend (Do) was $3.12, and dividends are expected to grow at a constant rate of 5.8%. The company's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated at 6%. For the own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% risk premium. (5) EVBOLT's target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity. Questions h through k: h. What is EVBOLT's weighted average cost of capital (WACC)? i. What factors influence a company's WACC? j. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What are three types of project risk? How can each type of risk be considered when thinking about the new division's cost of capital?
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