Question

My question is Q 9, calculating WACC , thank you!

7. Calculating Cost 8. Calculation USE OF debt? U atins Cost of Debt UI debt? If the tax rate Jiminy's Cricket Farm issued a 30-year, 7 percent miannual bond 3 years ago. The bond currently sells for 93 percent of its face value. The company's tax rate is 35 percent. a. What is the pretax cost of debt? b. What is the aftertas cost of debt? Which is more relevant, the pretax or the aftertax cost of debt? Why? leulat Cost of Debt R02 For the firm in Problem 7, suppose the book value the debt issue is 585 million. In addition, the company has a second debt issue on market, a zero coupon bond with 12 years left to maturity, the book value of this is $35 million, and the bonds sell for 59 percent of par. What is the company's book value of debt? The total market value? What is your best estimate of the aftertax cost of debt now? Calculating WACC [LO3] Mullineaux Corporation has a target capital structure 70 percent common stock, 5 percent preferred stock, and 25 percent debt. Its cost of equity is 11 percent, the cost of preferred stock is 5 percent, and the pretax cost of debt is 7 percent. The relevant tax rate is 35 percent. a. What is Mullineaux's WACC? b. The company president has approached you about Mullineaux's capital structure. He wants to know why the company doesn't use more preferred stock financing because it costs less than debt. What would you tell the president? 10. Taxes and WACC [LO3] Lannister Manufacturing has a target debt-equity ratio of 2 35. Its cost of equity is 12 percent, and its cost of debt is 6 percent. If the tax rate is 35 percent, what is the company's WACC? 11. Finding the Target Capital Structure (LO3] Fama's Llamas has a weighted aver- age cost of capital of 8.5 percent. The company's cost of equity is 11 percent, and its pretax cost of debt is 6.1 percent. The tax rate is 35 percent. What is the company's target debt-equity ratio? 12. Book Value versus Market Value [LO3] Dinklage Corp. has 8 million shares of common stock outstanding. The current share price is $73, and the book value per Share is $7. The company also has two bond issues outstanding. The first bond issue nas a face value of $85 million, a 7 percent coupon, and sells for 97 percent of par. The second issue has a face value of $50 million, an 8 percent coupon, and sells for 08 percent of par. The first issue matures in 21 years, the second in 6 years. b. What are the comp c. Which are more 13. Calculating the was $3.90 and the div at are the company's capital structure weights on a book value basis? t are the company's capital structure weights on a market value basis? ich are more relevant, the book or market value weights? Why? ulating the WACC ILO31 In Problem 12, suppose the most recent dividend and the dividend growth rate is 6 percent. Assume that the overall cost of of that implied by the two outstanding debt issues. Both What is the company's debt is the

Answer 1

Solution:

Wacc = We*Ke + Wp*Kp + Wd*Kd*(1-T)

WACC -> Weighted average cost of capital

We -> weight of equity , Ke- > cost of equity

Wp -> weight of preferred stock , Kp -> cost of preferred stock

Wd -> weight of debt, Kd -> cost of debt , T-> tax rate

given we have

We = 70% , Wp = 5% ,Wd = 25% , Ke = 11% , Kp=5% , Kd= 7% , T = 35%

Putting the values in the WACC formula we get ,

WACC = .70 * .11 + .05 * .05 + .25 * .07 * (1-.35)

WACC = .077 + .0025 + .011375

WACC = .090875 or 9.0875%

b) The response would be as follows:-

Though it is given that the preferred stock is a cheaper source of financing it has it set of disadvantage over debt i.e.

1. The interest on debt is tax deductible whereas the dividend paid on the preferred stock is paid out of the divisible profits of that company i.e. profit after taxes and all other expenses.
2. Debt provides a tax shield which preferred stock does not . Also in a no tax regime they would cost equal that's way too impractical to assume but.