Homework Answers
| 1 | After tax cost of each method of financing | |||||||||||||
| Cm | Mortgage Bond=4%*(1-Tax Rate)= | 2.80% | 4*(1-0.3) | |||||||||||
| Cu | Unsecured Bond=6*(1-tax rate) | 4.20% | 6*(1-0.3) | |||||||||||
| Cs | Common Stock=Risk free rate+Premium | 11% | (3+8) | |||||||||||
| 2 | ||||||||||||||
| A | Mortgage Bond= | $1 | million | |||||||||||
| B | Unsecured Bond | $5 | million | |||||||||||
| C | Common Stock | $11 | million | |||||||||||
| D | Total | $17 | million | |||||||||||
| Wm=A/D | Weight of Mortgage Bond= | 0.06 | ||||||||||||
| Wu=B/D | Weight of Unsecured Bond | 0.29 | ||||||||||||
| Ws=C/D | Weight ofCommon Stock | 0.65 | ||||||||||||
| Weighted Average Cost of Capital(WACC) | ||||||||||||||
| Cost of Mortgage Bond*Weight of Mortgage Bond+Cost of Unsecured Bond*Weight of Unsecured bond+Cost of Common Stock*Weight of Common Stock | ||||||||||||||
| WACC=Cm*Wm+Cu*Wu+Cs*Ws= | 8.52% | |||||||||||||
| Weighted Average Cost of Capital | 8.52% | |||||||||||||
| Dollar amount of capital employed | $17,000,000 | |||||||||||||
| 3 | Net Operating Income After Tax(NOPAT) | $1,196,500 | ||||||||||||
| WACC | 8.52% | |||||||||||||
| Capital Invested | $17,000,000 | |||||||||||||
| Economic Value Added (EVA)=NOPAT-(WACC*Capital Invested) | ||||||||||||||
| EVA=1196500-(8.52%*17000000)= | ($251,500.00) | |||||||||||||
| Company is destroying wealth | ||||||||||||||
| 4 | If the risk premium of common stock is 5% | |||||||||||||
| Cs | After tax cost of common stock=5+3 | 8% | ||||||||||||
| WACC=2.8*0.06+4.2*0.29+8*0.65 | 6.58% | |||||||||||||
| EVA=1196500-(6.58%*17000000)= | $78,500 | |||||||||||||
|
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