Which of the following statements is CORRECT? WACC calculations should be based on the before-tax costs of all the individual capital components. Flotation costs associated with issuing new common stock normally reduce the WACC. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. A change in a company's target capital structure cannot affect its WACC. 00000
Which of the following statements is CORRECT? WACC calculations should be based on the before-tax costs of all the individual capital components. Flotation costs associated with issuing new common stock normally reduce the WACC. If a company's tax rate increases, then, all else equal, its weighted average cost of capital will decline. An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing. A change in a company's target capital structure cannot affect its WACC. 00000
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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Concept explainers
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.
Question
Transcribed Image Text:### Understanding Weighted Average Cost of Capital (WACC)
When evaluating the statements related to WACC, consider the following options:
1. **WACC calculations should be based on the before-tax costs of all the individual capital components.**
2. **Flotation costs associated with issuing new common stock normally reduce the WACC.**
3. **If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decline.**
4. **An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.**
5. **A change in a company’s target capital structure cannot affect its WACC.**
Each statement examines different aspects and influences affecting the computation of WACC. Evaluate how costs, taxes, risk-free rates, and structural changes influence a company's financial strategy.
(Note: There are no graphs or diagrams in the provided content.)
Transcribed Image Text:**The Collins Group Financial Overview**
The Collins Group, a leading producer of custom automobile accessories, is analyzing the firm's weighted average cost of capital (WACC). Below is the balance sheet along with additional relevant information.
**Balance Sheet**
**Assets**
- Current assets: $38,000,000
- Net plant, property, and equipment: $101,000,000
- **Total assets: $139,000,000**
**Liabilities and Equity**
- Accounts payable: $10,000,000
- Accruals: $9,000,000
- **Current liabilities: $19,000,000**
- Long-term debt (40,000 bonds, $1,000 par value): $40,000,000
- **Total liabilities: $59,000,000**
- Common stock (10,000,000 shares): $30,000,000
- Retained earnings: $50,000,000
- **Total shareholders' equity: $80,000,000**
- **Total liabilities and shareholders' equity: $139,000,000**
**Market and Financial Data**
- Current stock price: $15.25 per share
- Bonds: Noncallable, $1,000 par value, 20-year, 7.25% interest, selling for $875.00
- Beta: 1.25
- Yield on a 6-month Treasury bill: 3.50%
- Yield on a 20-year Treasury bond: 5.50%
- Required return on the stock market: 11.50%
- Average annual market return over past 5 years: 14.50%
- Firm’s tax rate: 40%
This case involves the calculation of the firm's weighted average cost of capital, requiring analysis of the provided financial data and balance sheet.
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