EP FUNDAMENTALS OF FIN.MGMT.-MINDTAP
14th Edition
ISBN: 9781305672086
Author: Brigham
Publisher: CENGAGE L
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Chapter 10, Problem 1TCL
CALCULATING 3M’s COST OF CAPITAL
In this chapter, we described how to estimate a company’s WACC, which is the weighted average of its costs of debt,
1. As a first step, we need to estimate what percentage of MMM’s capital comes from debt, preferred stock, and common equity. This information can be found on the firm’s latest annual
- a. Recall that the weights used in the WACC are based on the company’s target capital structure. If we assume that the company wants to maintain the same mix of capital that it currently has on its balance sheet, what weights should you use to estimate the WACC for MMM?
- b. Find MMM’s market capitalization, which is the market value of its common equity. Using the sum of its short-term debt and long-term debt from the balance sheet (we assume that the market value of its debt equals its book value) and its market capitalization, recalculate the firm’s debt and common equity weights to be used in the WACC equation. These weights are approximations of market-value weights. Be sure not to include accruals in the debt calculation.
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The market values and after-tax costs of various sources of capital used by Ridge Tool are shown in the following table attached:
a. Calculate the firm's weighted average cost of capital.
b.Explain how the firm can use this cost in the investment decision-making process.
.Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 0.70. Based on the CAPM approach, what is the cost of equity?
Cost of Capital (WACC)
WACC = (E/V) × RE+ (D/V) × RD × (1 - Tc)
(20 points)
2. You will be working as an analyst for Berkshire Hathaway. To prepare for their interview, you were
told they use different ways to calculate the cost of capital of the companies they buy. One of them is
the Weighted Cost of Capital or WACC.
The BH team provided the following data and asked you to calculate the WACC of a target company
they are evaluating for acquisition.
(in millions)
Value of Equity
$275
Yield of Debt
7.53%
Value of Debt
$897
Tax rate
13.51%
Return equity
15.21%
a. What is the company's total value using the value of debt and equity? Provide the result as $000
(mn).
b. What is the weighted average cost of capital? Provide the result as x.xx%.
Chapter 10 Solutions
EP FUNDAMENTALS OF FIN.MGMT.-MINDTAP
Ch. 10 - Prob. 1QCh. 10 - Assume that the risk-free rate increases, but the...Ch. 10 - How should the capital structure weights used to...Ch. 10 - Prob. 4QCh. 10 - The WACC is a weighted average of the costs of...Ch. 10 - AFTER-TAX COST OF DEBT The Heuser Companys...Ch. 10 - COST OF PREFERRED STOCK Tunney Industries can...Ch. 10 - COST OF COMMON EQUITY Percy Motors has a target...Ch. 10 - COST OF EQUITY WITH AND WITHOUT FLOTATION Javits ...Ch. 10 - PROJECT SELECTION Midwest Water Works estimates...
Ch. 10 - COST OF COMMON EQUITY The future- earnings,...Ch. 10 - COST OF COMMON EQUITY WITH AND WITHOUT FLOTATION...Ch. 10 - COST OF COMMON EQUITY AND WACC Pattern Paints...Ch. 10 - WACC The Patrick Companys year-end balance sheet...Ch. 10 - WACC Klose Outfitters Inc. believes that its...Ch. 10 - WACC AND PERCENTAGE OF DEBT FINANCING Hook...Ch. 10 - WACC Midwest Electric Company (MKC) uses only debt...Ch. 10 - COST OF COMMON EQUITY WITH FLOTATION Ballack Co.s...Ch. 10 - COST OF PREFERRED STOCK INCLUDING FLOTATION...Ch. 10 - WACC AND COST OF COMMON EQUITY Kahn Inc. has a...Ch. 10 - COST OF COMMON EQUITY The Bouchard Companys EPS...Ch. 10 - CALCULATION OF g AND EPS Sidman Productss common...Ch. 10 - WACC AND OPTIMAL CAPITAL BUDGET Adams Corporation...Ch. 10 - ADJUSTING COST OF CAPITAL FOR RISK Ziege Systems...Ch. 10 - WACC The following table gives Foust Companys...Ch. 10 - CALCULATING THE WACC Here is the condensed 2015...Ch. 10 - Prob. 22ICCh. 10 - CALCULATING 3Ms COST OF CAPITAL In this chapter,...Ch. 10 - Prob. 2TCLCh. 10 - CALCULATING 3Ms COST OF CAPITAL In this chapter,...
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- CALCULATING 3Ms COST OF CAPITAL In this chapter, we described how to estimate a companys WACC, which is the weighted average of its costs of debt, preferred stock, and common equity. Most of the data we need to do this can be found from various data sources on the Internet. Here we walk through the steps used to calculate Minnesota Mining Manufacturings (MMM) WACC. 3. Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it. One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at close to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the companys home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Remember that you need the after-tax cost of debt to calculate a firms WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?arrow_forwardPlease describe a working capital management for 2 companies. 1. How their financial figure will be calculated. 2. Explain their performance. 3. Examine both of the companies based on risk factors; the upside and the dowside. 4. How is the justification should be dne based on their data and ratio. 5. Conclusion on the analysis.arrow_forwardWACC-Book weights and market weights Webster Company has compiled the information shown in the following table: a. Calculate the weighted average cost of capital using book value weights. b. Calculate the weighted average cost of capital using market value weights. c. Compare the answers obtained in parts a and b. Explain the differences. a. The firm's weighted average cost of capital using book value weights is %. (Round to two decimal places.) i Data Table (Click on the icon located on the top-right corner of copy its contents into a spreadsheet.) data table bel order to Source of capital Book value Market value After-tax cost Long-term debt $4,000,000 $3,840,000 8% Preferred stock 40,000 65,000 13% Common stock equity 1,060,000 4,484,000 15% Totals $5,100,000 $8,389,000 Print Donearrow_forward
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- Assume that you have been hired as a consultant by CGT, a major producer of chemicals and plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted average cost of capital. The balance sheet and some other information are provided below. Assets Current Assets Net, plant, property, and equipment Total assets $ $ $ Liabilities and Equity Accounts payable Accruals Current Liabilities Long-term debt (40,000 bonds, $1,000 par valu $ Total liabilities $ Common stock (10,000,000 shares) $ Retained earnings Total shareholders equity Total liabilities and shareholder's equity $ $ $ $ $ $ 38,000,000 101,000,000 139,000,000 10,000,000 9,000,000 19,000,000 40,000,000 59,000,000 30,000,000 50,000,000 80,000,000 139,000,000 The Stock is currently selling $15.25 per share, and its noncallable $1000 par value, 20 year, 7.25% bonds semiannual payments are selling for $875. The beta is 1.25, the yield on a 6-month treasury bill is 3.50% and the yield on a…arrow_forward1. Download the financial statements of any company and do the following analysis? a) Calculate and Comment on the gearing ratio of the companies? b) Write a note on the nature of the capital structure of the company and highlight the importance of leverage in capital structure. please mention the reference at the endarrow_forwardWhat is WACC (select all that are true)? Group of answer choices Rd (1-Tc) * D/V + Re * E/V Weighted Average Cost of Capital For a firm overall, it is based on the riskiness of the firm's assets While it is generally estimated by looking at the right-hand-side of the balance sheet, it is largely driven by the left-hand-side (i.e., assets) It is the amount that equity holders demand for an investment in a firm It is the amount that debt holders demand for a loan made to the firmarrow_forward
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What is WACC-Weighted average cost of capital; Author: Learn to invest;https://www.youtube.com/watch?v=0inqw9cCJnM;License: Standard YouTube License, CC-BY