Solution to Integrative problem. Nealon, Inc. - Weighted cost of capital

Nealon, Inc. - Weighted Cost of Capital

Cost of Debt:

$1,035 (1 -.15) = $879.75 = NPd

$879.75 = +

RateValueValue

For: 9% $917.04 $917.04

kd% 879.75

10% 843.92

$ 37.29$ 73.12

kd = 0.09 + =.0951 = 9.51%

= 9.51%(1 -.34) = 6.28%

Cost of Preferred Stock:

kps = = = 8.83%

Cost of Internal Common Equity:

kcs = + g

= + 0.06

=.1357 = 13.57%

Weighted Cost of Capital (k_wacc) is calculated as follows:

WeightsCostsWeighted Costs

Bonds.38 6.28% 2.39%

Preferred Stock.15 8.83% 1.32%

Common Stock .47 13.57% 6.38%

1.00 k_wacc = 10.09%

Solutions for Problem Set B

The following notations are used in this group of problems:

kps = the cost of preferred stock.

kcs = the cost of internally generated common funds

kncs = the cost of new common stock.

g = the growth rate.

kd = the before-tax cost of debt.

T = the marginal tax rate.

Dt = dollar dividend per share, where Do is the most recently paid dividend and D1is the forthcoming dividend.

P = the value (present value) of a security.

NP = the value of a security less any flotation costs incurred in issuing the security

12-1B.

a. Net price after flotation costs = $1,125 (1 -.06)

= $1,057.50

$1,057.50 = +

RateValueValue

For: 11% $1,058.68 $1,058.68

kd% 1,057.50

12% 1,000.00

$ 1.18$ 58.68

kd =.11 + ´.01 =.1102 = 11.02%

= kd(1 - T)

= 11.02%(1 -.34) = 7.27%

b. kncs = + g

= +.08

=.1511 = 15.11%

c. kcs = + g

= +.07

=.1447 = 14.47%

d. kps = =

=

=.0947 = 9.47%

e. = kd(1 - T)

= 13% (1 -.34)

= 8.58%

12-2B.

a. = kd(1 - T)

= 9%(1 - 0.34)

= 5.94%

b. kncs = + g

kncs = + 0.06 = 10.85%

c. $1,125(.90) = $1,012.50 = net price after flotation costs

$1,012.50 = +

RateValueValue

For: 12% $1,074.97 $1,074.97

k_d% 1,012.50

13% 1,000.00

$ 62.47$ 74.97

k_d = 0.12 + 0.01 =.1283 = 12.83%

= k_d(1 - T)

= 12.83% (1 - 0.34) = 8.47%

d. kps =

kps = = 9.72%

e. kcs = + g

kcs = + 0.05 = 15.52%

12-3B. kncs = + g

kncs = + 0.07 =.1229 = 12.29%

12-4B. $950 (1 - 0.11) = $845.50 = the net price (value less flotation costs).

$845.50 = +

RateValueValue

For: 10% $847.48 $847.48

k_d% 845.50

11% 784.28

$1.98 $63.20

kd = 0.10 + ´ 0.01 =.1004 = 10.04%

= 10.04% (1 - 0.19) = 8.13%

12-5B. kps = = = 8.46%

12-6B. NP_d = +

$950 = +

Since the net price on the bonds, $950, is less than the $1,000 par value, the before-tax cost of the debt must be greater than the 13 percent coupon interest rate ($130 ÷ $1,000).

RateValueValue

13% $1,000.00 $1,000.00

kd% 950.00

14% 938.46

$ 50.00$ 61.54

kd =.13 + ´.01 =.1381 = 13.81%

= kd(1 - T) = 13.81%(1 -.34) = 9.11%

12-7B. Cost of preferred stock (kps)

= =

= =

= 13.40%

12-8B. kcs = + g

= + 0.16

=.2012 = 20.12%

12-9B. If the firm pays out 50 percent of its earnings in dividends, its recent earnings must have been $9 ($4.50 dividend divided by.5).

Thus, earnings increased from $5 to $9 in five years. Using Appendix C and looking for a table value of.556 ($5/$9), the annual growth rate is approximately twelve percent.

a. Cost of internal common stock (kcs):

kcs = + g

= +.12

= +.12

=.204 = 20.4%

b. Cost of external common (new common) stock, kncs

kncs = + g

= +.12

= +.12

=.2123 = 21.23%

12-10B.

a. Price (P_d) = +

= $150(6.145) + $1000(.386)

= $1,307.75

b. NP_d = $1,307.75(1 - 0.115)

= $1,157.36

c. Number of Bonds =

= 518.4 ≈ 519 bonds

d. Cost of debt:

$1,157.36 = +

RateValueValue

For 12% $1,169.50 $1,169.50

kd% 1,157.36

13% 1,108.90

$ 12.14$ 60.60

kd = 0.12 + = 12.20%

= 12.20%(1 - 0.34) = 8.05%

12-11B.

a. 1. Price (P_d) = +

= $100 (6.145) + $1,000 (.386)

= $1,000.00

2. NP_d = $1,000.00 (1 - 0.115)

= $885.00

3. Number of Bonds =

= 678 Bonds

4. Cost of debt:

$885.00 = +

		Value	Value
For:	12%	$887.00	$887.00
	kd%	885.00
	13%		837.60
		$2.00	$49.40

kd = 0.12 + =.1204 = 12.04%

= 12.04%(1 - 0.34) = 7.95%

b, There is a very slight decrease in the cost of debt because the flotation costs associated with the higher coupon bond are higher (flotation costs are $150.39 for the 15 percent coupon bond versus $115 for the 10 percent coupon bond)

12-12B. Bias Corporation - Weighted Cost of Capital

Capital Individual Weighted

StructureWeightsCostsCosts

Bonds $1,100 0.2178 6.0% 1.31%

Preferred Stock 250 0.0495 13.5% 0.67%

Common Stock 3,7000.7327 19.0% 13.92%

$5,050 1.0000 15.90%

12-13B.

Source	Capital Structure	After-tax cost of capital	Weighted cost
Common Stock	50%	20%	10.0%
Preferred Stock	15%	12%	1.8%
Debt	35%	10% (1-.34)	2.3%
	100%	kwacc =	14.1%

12-14B.

Net price after flotation costs = $1,100- $20

= $1,080.00

Cost of debt:

$1,080.00 = +

Semi-annual RateValueValue

For: 3% $1,231.60 $1,231.60

k_d% 1,080.00

4% ________ 1,000.00

$ 151.60$ 231.60

semi-annual kd = 0.03 + =.0365 = 3.65%

annual k_d = 3.65% x 2 = 7.3%

= 7.3%(1 - 0.34) = 4.8%

Cost of common stock, kncs

kncs = + g

= +.08

=.108 = 10.8%

Source	Capital Structure	After-tax cost of capital	Weighted cost
Common Stock	60%	10.8%	6.48%
Debt	40%	4.8%	1.92%
		kwacc =	8.4%

12-15B.

Net price after flotation costs = $950 (1-.06)

= $893.00

Cost of debt:

$893.00 = +

RateValueValue

For: 9% $908.32 $908.32

k_d% 893.00

10% ________ 830.12

$ 15.32$ 78.20

kd = 0.09 + =.092 = 9.2%

= 10.4 % x (1 - 0.34) = 6.07%

Cost of preferred stock (kps)

k_ps = =

= =

=.083 = 8.3%

Cost of common stock, kncs

kncs = + g

= +.08

=.128 = 12.8%

Source	Market Value	Weight	After-tax cost of capital	Weighted Cost
Bonds	$500,000	.50	6.07%	3.04%
Preferred Stock	100,000	.10	8.3%	.83%
Common Stock	400,000	.40	12.8%	5.12%
	$1,000,000	1.00	kwacc =	8.99%

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