Define each of the following terms: a. Weighted average cost of capital, WACC; after-tax cost of debt, r d (1 – T); after-tax cost of short-term debt, r std (1 – T) b. Cost of preferred stock , r ps ; cost of common equity (or cost of common stock), r s c. Target capital structure d. Flotation cost, F; cost of new external common equity, r e

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Answer 1

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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(d) Estimate the value of a share of Cisco common stock using the discounted cash flow (DCF) model as of July 27, 2019 using the following assumptions Assumptions Discount rate (WACC) Common shares outstanding 7.60% 5,029.00 million Net nonoperating obligations (NNO) $(8,747) million NNO is negative, which means that Cisco has net nonoperating investments CSCO ($ millions) DCF Model Reported 2019 Forecast Horizon 2020 Est. 2021 Est. 2022 Est. 2023 Est. Terminal Period Increase in NOA FCFF (NOPAT - Increase in NOA) $ 1241 1303 1368 10673 11207 11767 1437 $ 12354 302 ✓ Present value of horizon FCFF 9918 9679 9445 ✔ 0 × Cum. present value of horizon FCFF $ 0 × Present value of terminal FCFF 0 ☑ Total firm value 0 ☑ NNO -8747 ✓ Firm equity value $ 0 ☑ Shares outstanding (millions) 5029 Stock price per share $ 40.05

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Answer 2

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 3

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 4

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 8

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Answer 13

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 14

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 15

b)

Expert Solution

Answer 16

b)

Expert Solution

Answer 17

Expert Solution

Answer 18

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Answer 19

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 20

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 21

c)

Expert Solution

Answer 22

c)

Expert Solution

Answer 23

Expert Solution

Answer 24

Summary Introduction

To discuss: Target capital structure.

Answer 25

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 26

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 27

d)

Expert Solution

Answer 28

d)

Expert Solution

Answer 29

Expert Solution

Answer 30

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Answer 31

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 32

Ch. 11 - Define each of the following terms: Weighted...Ch. 11 - Prob. 2Q Ch. 11 - Prob. 3Q Ch. 11 - Distinguish between beta (i.e., market) risk,...Ch. 11 - Suppose a firm estimates its overall cost of...Ch. 11 - 11-1 After-Tax Cost of Debt Calculate the...Ch. 11 - Prob. 2P Ch. 11 - Cost of Preferred Stock Duggins Veterinary...Ch. 11 - Prob. 4P Ch. 11 - Prob. 5P

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