## WarmUp Exercises a blue box indicates

exercises available in ^ rcyfiaancelab|

r»?| El 1—1 Weekend Warriors, Inc., has 35% debt and 65% equity in its capital structure.

Wj The firm's estimated after-tax cost of debt is 8 % and its estimated cost of equity is

13%. Determine the firm's weighted average cost of capital (WACC).

fPSj QH3 A firm raises capital by selling \$20,000 worth of debt with flotation costs equal to Zj 2% of its par value. If the debt matures in 10 years and has a coupon interest rate of

J?a ET1-3 Your firm, People's Consulting Group, has been asked to consult on a potential

Iff preferred stock offering by Brave New World. This 15% preferred stock issue would be sold at its par value of \$35 per share. Flotation costs would total \$3 per share. Calculate the cost of this preferred stock.

§12033 Duke Energy has been paying dividends steadily for 20 years. During that time, dividends have grown at a compound annual rate of 7%. If Duke Energy's current stock price is \$78 and the firm plans to pay a dividend of \$6.50 next year, what is Duke's cost of common stock equity?

Oxy Corporation uses debt, preferred stock, and common stock to raise capital. The firm's capital structure targets the following proportions: debt, 55%; preferred stock, 10%; and common stock, 35%. If the cost of debt is 6.7%, preferred stock cosrs 9.2%, and common stock costs 10.6%, what is Oxy's weighted average cost of capital (WACC)?

Problems A blue box (a) indicates problems available in ^myTmaiicelab^

Concept of cost of capital Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past month were projects 263 and 264. The basic variables surrounding each project analysis, using the IRR decision technique, and the resulting decision actions are summarized in the following table.

Cost \$64,000 \$58,000

Life 15 years 15 years

IRR 8% 15% Least-cost financing

Source Debt Equity

Cost (after-tax) 7% 16% Decision

### Action Accept Reject

Reason 8% IRR>7% cost 15% IRR< 16% cost a. Evaluate the firm's decision-making procedures, and explain why the acceptance of project 263 and rejection of project 264 may not be in the owners' best interest.

b. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table.

c. If the firm had used the weighted average cost calculated in part b, what actions would have been indicated relative to projects 263 and 264?

d. Compare and contrast the firm's actions with your findings in part c. Which decision method seems more appropriate? Explain why.

BUI Cost of debt using both methods Currently, Warren Industries can sell 15-year,

\$l,000-par-value bonds paying annual interest at a 12% coupon rate. As a result of current interest rates, the bonds can be sold for \$1,010 each; flotation costs of \$30 per bond will be incurred in this process. The firm is in the 40% tax bracket.

a. Find the net proceeds from sale of the bond, Nj.

b. Show the cash flows from the firm's point of view over the maturity of the bond.

c. Use the IRR approach to calculate the before-tax and after-tax costs of debt.

d. Use the approximation formula to estimate the before-tax and after-tax costs of debt.

e. Compare and contrast the costs of debt calculated in parts c and d. Which approach do you prefer? Why? . .

### Personal Finance Problem -

ILjdLKfcg Before-tax cost of debt and after-tax cost of debt David Abbot is interested in purchasing a bond issued by Sony. He has obtained the following information on the security:

Par value 51,000 Coupon interest rate 6% Tax bracket 20% Cost \$ 930 Years to maturity 10

Par value 51,000 Coupon interest rate 6% Tax bracket 20% Cost \$ 930 Years to maturity 10

a. Calculate the before-tax cost of the Sony bond using the IRR method.

b. Calculate the after-tax cost of the Sony bond given David's tax bracket.

P11-4 Cost of debt using the approximation formula For each of the following \$1,000-par-value bonds, assuming annual interest payment and a 40% tax rate, calculate the after-tax cost to maturity using the approximation formula.

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### Responses

• Barbara Kastner
Has a target capital structure of 40% debt and 60% equity?
6 years ago