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Chapter 14 - Cost of Capital
Chapter 14 - Cost of Capital
PROBLEM #1
CALCULATION OF THE COST OF SHARE CAPITAL
1. Calculating the cost of equity capital (LO1) The Down and Out Co. just delivered
dividends of $2.40 per common share. The company is expected to have a constant
dividend growth rate of 5.5% indefinitely. shares sell for $52, what is the company's
cost of equity capital?
PROBLEM #1.................................................................................................1
CALCULATION OF THE COST OF SHARE CAPITAL............................1
PROBLEM #2.................................................................................................4
CALCULATION OF THE COST OF SHARE CAPITAL............................4
PROBLEM #3.................................................................................................4
CALCULATION OF THE COST OF SHARE CAPITAL............................4
ARITHMETIC GROWTH RATE..................................................................5
GEOMETRIC AVERAGE GROWTH RATE...............................................5
PROBLEM #5.................................................................................................5
CALCULATION OF THE COST OF PREFERRED SHARES....................5
PROBLEM #6.................................................................................................5
CALCULATION OF THE COST OF DEBT.................................................5
ANNUAL........................................................................................................5
BIANNUAL....................................................................................................5
PROBLEM #7.................................................................................................6
CALCULATION OF THE COST OF DEBT.................................................6
PROBLEM #8.................................................................................................6
CALCULATION OF THE COST OF DEBT.................................................6
PROBLEM #9.................................................................................................7
CPPC CALCULATION.................................................................................7
10.52%............................................................................................................8
PROBLEM #10...............................................................................................8
TAXES AND CPPC.......................................................................................8
CPPC = (E/V) x R f + (D/V) x R iy x (1 - T c ).....................................................8
PROBLEM #11...............................................................................................8
DETERM OF THE CAPITAL STRUCTURE SET AS A GOAL.................8
CPPC = ( E / V ) ´ R E + ( D / V ) ´ R D ´ (1 - T C ).................................................9
PROBLEM #12...............................................................................................9
BOOK VALUE AND MARKET VALUE.....................................................9
[14.6].................................................................................................................11
[14.7].................................................................................................................11
ONTED.........................................................................................................12
8.04%............................................................................................................13
8.03%............................................................................................................13
PROBLEM #13.............................................................................................23
CPPC CALCULATION...............................................................................23
PROBLEM #14.............................................................................................23
CPPC.............................................................................................................23
CPPC = ( E / V ) ´ R E + ( D / V ) ´ R D ´ (1 - T C )...............................................23
COST OF DEBT BEFORE TAXES.............................................................23
COMMON CAPITAL COST.......................................................................23
PROBLEM #15.............................................................................................24
DETERMINATION OF CPPC.....................................................................24
bd 1.43
1.05
RFQ RISK FREE RATE 45
5.30%
RM MARKET PERFORMANCE 12%
YEARS
KS = Rf + b * (Rm-Rf) DIVIDENDS
12.34% CHANGE $
4 1.05
3 1.12 0.07
2 1.19 0.07
PROBLEM #3 1 1.3 0.11
CALCULATION OF THE0COST OF SHARE CAPITAL 1.43 0.13
3. Calculating the Cost of Equity Capital (LO1) Country Road stock has a beta of .85.
The market risk premium is 8% and today Treasury certificates have a yield of 5%.
ARITHMETIC
Emp's most GROWTH RATE were $1.60 per share and are expected to grow
recent dividends
indefinitely at
GEOMETRIC an annualGROWTH
AVERAGE rate of 6%. If the stock sells for $37 per unit, what is your
RATE
best estimate of the company's cost of equity capital?
K. 1.54497330182073
S. 1.54480164083396
K. D1
b
S. 0.85
IT IS ALREADY THE DIFFERENCE MARKET 8% RI PREMIUM
PERFORMANCE 5%
PROBLEM
RF RISK FREE#5 RATE 1.6
CALCULATION OF THE COST OF PREFERRED SHARES 1.696
DO
5. Calculating the cost of preferred stock (LO1) Holdup Bank has an issue of preferred
D1 with stated dividends of $6 that it has just sold for $1 per share.6%
stock What is the cost
of $ 37.00
G the bank's preferred
GROWTH RATE stock?
PRICE
KS R = PER
D1/POSHARE
+G 10.58%
CAPM KS = Rf + b * (Rm-Rf) 11.80%
DIV PREFERRED
PROBLEM #4 SHARES
PRICE
CALCULATION OF GROWTH RATE USING DESCRIPTION CASH FLOW 96
K.4. Calculating Growth Rate Using Discounted Cash Flow 6.25%
(LO1) Suppose that In a Found Ltd. has just announced dividends of $1.43 per
P.common share. The company paid dividends of $1.05, $1.12, $1.19 and $1.30 per ac
over the previous four years. If the current stock price is $45, what
PROBLEM #6
CALCULATION OF THE COST OF DEBT
6. Calculating the cost of debt (LO2) Waller, Inc., wants to determine the cost of its
debt. The company has a debt issue outstanding with a maturity of 15 that is trading
at 107% of its face value. The issue makes semiannual payments and has an
incorporated cost of 7% annually. What is Advance's cost of debt before taxes? If the
tax rate is 35%, what is the after-tax cost?
ANNUAL BIANNUAL
NOMINAL VALUE 1000 1000
EXPIRATION 15 30
IT IS QUOTED 107% 1070
SEMESTERLY INTEREST PAYMENTS 70 35
INCORPORATED COST COUPON RATE 7% 3.5%
TAXES 35% 35% 35%
K.D. ADVANCE COST BEFORE TAXES 6.27% 3.14%
KI COST AFTER TAX 4.07%
PROBLEM #7
CALCULATION OF THE COST OF DEBT
7. Calculation of the cost of debt (LO2) Seven years ago Jiminy's Cricket Farm
issued a bond with a maturity of 30 years and an interest rate of 8% with semiannual
payments. Today, bond sells at 95% of its face value. The company's tax rate is
a) What is the cost of debt before taxes?
b) What is the cost of debt after taxes?
c) What is more important, the cost of debt before or after taxes? By
ANNUAL BIANNUAL
NOMINAL VALUE 1000 1000
EXPIRATION 23 46
IT IS QUOTED 95% 950
SEMESTERLY INTEREST PAYMENTS 80 40
INCORPORATED COST COUPON RATE 8% 4%
TAXES 35% 35% 35%
DEBT 1
K.D. ADVANCE COST BEFORE TAXES 8.50% 4.25%
KI COST AFTER TAX 5.53%
PROBLEM #8
CALCULATION OF THE COST OF DEBT
8. Calculation of the cost of debt (LO2) For the company in problem 7, assume that
the book value of the debt issue is 80 million. In addition, the company has a debt
issue in the market, a zero-coupon bond that has seven years left until maturity. The
book value of this issue is $35 million and the bond is sold at 61% of par value. What
is the total book value of the company's debt? What is the total market value? What
is your best estimate now after-tax cost of debt?
SEMESTERLY ANNUAL
NOMINAL VALUE $ 1,000.00
DEBT 1 BOOK VALUE $ 80,000,000.00
DEBT 2 BOOK VALUE $ 35,000,000.00
COUPON RATE 0%
EXPIRATION 7 14
BOND PRICE CURRENT VALUE 61% 610
DEBT 2 7.19%
K.D. ADVANCE COST BEFORE TAXES 7.32% 3.59%
KI COST AFTER TAX 4.67%
TOTAL COST OF DEBT AFTER TAXES 5.34%
PROBLEM #9
CPPC CALCULATION
9. CPPC Calculation (LO3) Mullineaux Corporation pursues a capital structure of
60% common stock, 5% preferred stock, and 35% debt. The cost of common equity is
14%, the cost of preferred stock is 6%, and the cost of debt is 8%. The applicable tax
rate is 35%.
a) What is Mullineaux's CPPC?
b) Does the president of the company consult with you about Mullineaux's capital
structure? He wants to know why the company doesn't have more preferred stock
financing. What would you say to the president?
CAPITAL STRUCTURE
COMMON ACTIONS 60%
PREFERRED STOCK 5%
DEBT 35%
100%
TAXES 35%
THE COST OF DEBT AFTER TAX IS MUCH CHEAPER AND IM PLT COMPANIES
PREFER TO GET INDEBT WITH DEBT THAN WITH STOCKS
PROBLEM #10
TAXES AND CPPC
10. Taxes and CPPC (LO3) Sixx MM Manufacturing targets a deu ratio of .65. The
company's cost of common equity is 15% and the cost of debt is 9%. If the tax rate is
35%, what is the company's CPPC?
PROBLEM #11
DETERM OF THE CAPITAL STRUCTURE SET AS A GOAL
11. Determination of the target capital structure (LO3) Fama's Llama has a weighted average cost of
capital of 8.9%. The company's cost of common equity is 12% and its cost of debt is 7.9%. The tax rate
is 35. What is Captain's desired debt-to-equity ratio?
CPPC 8.90%
K.S. Re COST OF COMMON CAPITAL 12%
K.D. COST OF DEBT 7.90%
TAX RATE 35%
PROBLEM #12
BOOK VALUE AND MARKET VALUE
12. Book value and market value (LO3) Filer Manufacturing has 11 million common
shares outstanding. The current share price is $68 and the book value per share is $6.
Filer Manufacturing also has two bond issues outstanding. The first issue has a face
value of 70 million dollars, the coupon rate is 7% and is sold at 93% of its par value.
The second issue has a face value of 55 million, a coupon rate of 8% and is sold at 10
par value. The first issue expires in 21 years; the second, in six years.
a) What are the weights of Filer's capital structure based on its book value?
INAR
[14.6]
e must win the os. It is also i essentially the ar the 3 discount flows that
[14.7]
s rea
to
hear
MARKET BIAS
common actions
p0=d1/rg
d1=d0*(1+g)
-d1/d0*1=g
r=(d1/p0)+g
β = if it is 0 there is
no king
R=Rf+β(Rm-Rf)
ONTED
Kp=preferred
r shares ks=common
tio shares kd=cost of
n debt (
to YO.:---+e J_.--------
the
of ki= cost after C
I feel
CHANGE % EXERCISE 4 45 4
d0 3
6.67% p0 8.03% 2
6.25% 8.04% 1
9.24% crec geom 0
10.00% arithm
1.43 year
8.04%
8.03%
11.47%
11.46%
96
year
s
an
d
ye
s?
n
35%.
that?
he
aft
er
hi
m
tha
t of
DEBT
th
e
A
is
8.40%
0.30%
1.82%
INCOME POSITION MAKES MY PREFERRED COST
LOWER I. Cost of equity capital, R,
dacapital R=R,+Bx(RR)
where R is the free rate of risk
and is the systematic risk of the
cap
s
th
e
%.
0.0514
s of lor
J.
4% ado?
RCADO AND THIS IS WHAT YOU WILL RECEIVE
ERCADO IS GREATER THAN THE VALUE IN
BOOKS
MARKET TO - RISK FREE RATE)
sgo entities
is
REND REQDO)
and taxes
go, R u is the expected return in the general market and B, ital stock.
Publicly, the cost of debt is measured as the yield on sulation. The coupon rate is irrelevant. Performance to title 7.
Public debt, the cost of debt is measured as the yield on similar debt (Chapter 7 discusses the debt rating).
sapital, CPPC
general performance required of the company as a whole. It is used for cash flows of similar risk to those of the
,*(1-T)
os of the company, E is the value in the capital market E + D. Note that EN is the percentage of market r financing) that is
equity and D/V is the percentage
PROBLEM #13 VALDEZ
VICKY GARCIA
CPPC CALCULATION
CORPORATE FINANCE II
13. Calculation of the CPPC (LO3) In problem 12, assume that the most recent dividends
YOLANDA
were $4.10PINZON
and that the dividend growth rate was 6%. Assume that the overall cost of
debt is the weighted average of what is implied by the two outstanding debt issues.
Both bonds make semiannual payments. The tax rate is 35%. What is the company's
CPPC?
PROBLEM #14
CPPC
14. CPPC (OA3) Jungle , Inc., has a target debt-to-equity ratio of 1.05. Its CPPC is 9.4%
and the tax rate is 35%.
a) If Jungle, Inc.'s cost of common equity is 14%, what is its cost of debt before taxes?
b) If instead the after-tax cost of debt is known to be 6.8%, what is the cost of common
equity?
DIVIDENDS 4.1
GROWTH RATE 6%
CURRENT SHARE PRICE $ 68.00
D1 $ 4.35
OVERALL COST OF DEBT 79.00%
SEMESTER PAYMENT 39.50% 0.25675707
TAX RATE 35%
CPPC 38.07%
RZ D/C 1.05
CPPC IMP 9.40%
RATE 35%
COST CC 14%
KI - RD 6.80%
CPPC = ( E / V ) ´ R E + ( D / V ) ´ R D ´
(1 - T C )
COST OF DEBT BEFORE TAXES
CPPC - (1/1+RZDC)(RE) = RD
(RZDC/1+RZDC)(1-TIMP) 7.72%
PROBLEM #15
DETERMINATION OF CPPC
15. Determination of the CPPC (OA3) Given the following information from Evenlow Power Co.,
determine the CPPC. Assume the company's tax rate is 35%. Debt: 8,000 bonds outstanding with
6.5% coupon rate, $1,000 par value, 20-year maturity, sale 92% of par value; The bonds make
semiannual payments. Common stock: 250,000 shares outstanding, selling at $57 per
stock, beta of 1.05. Preferred Stock: 15,000 preferred shares outstanding at 5%, currently selling
for $93 per share. Market: market risk premium of 8% and risk-free rate of 4.5%.
CPPC 9.80%
23005000
RD
3.63
%
7.26
%
CER
12.90
%
RF
5.00
%
[114.7
]