Calculating the weighted cost of capital for a firm

Reference no: EM13746551

In this task, you will be calculating the weighted cost of capital for a firm using the book value of the components and the concepts presented in this phase.

Using the most current annual financial statements from the company you analyzed in Phase 1, determine the percentage of the firm's assets that are currently be financed with debt (total liabilities), preferred stock, and common stock (common equity). It is very possible that your firm will have very little or no preferred stock, so in this class, the percent would be "zero." Your ratios should add up to 100%. You will also need to calculate the firm's average tax rate using the income tax expense divided by the firm's income before taxes. Use the following tables:

in thousands

Company	Total Assets	Total Liabilities	Total Preferred Stock	Total Common Equity
Dollar Value	36,626,300	20,616,600	0	16,009,700
% of Assets	100	56	0	44

Company	Income before Tax	Income Tax Expense	Average Tax Rate (%)
Mc Donald	8,204,500	2,618,600	32

The first component to determine is the cost of debt. You mentor suggests using the Web site that you used in the previous Phase to find the pretax yield-to-maturity of a bond with at least 5 years left before maturity. Using the following table, calculate the firm's after-tax cost of debt:

Yield to Maturity	1 - Average Tax Rate	After-tax Cost of Debt
6.45	0.68	4.386

Now you will need to calculate the cost of preferred stock. You can use the following table:

Annual Dividend	Current Value of Preferred Stock	Cost of Preferred Stock (%)
0	0	0

To calculate the cost of common equity, you can use the CAPM model. Using current stock data, the yield on the 5-year Treasury bond, and the return on the market calculated in Phase 2, you can calculate the cost of common equity using the following table:

5-year Treasury Bond Yield (risk-free rate)	Stock's Beta	Return on the Top 500 Stocks (market return)	Cost of Common Equity
1.74	0.34	19.6	7.81

Now, you can use the cost and ratios from above to calculate the firm's weighted average cost of capital (WACC) using the following table:

	After-Tax Cost of Debt	Cost of Preferred Stock	Cost of Common Equity	WACC
Unweighted Cost	4.386	0	7.81	12.196
Weight of Component	0.56	0	0.44
Weighted Cost of Component	2.456	0	3.436	5.893

After completing the required calculations, explain your results in a Word document, and attach the spreadsheet showing your work. Be sure to explain the following:
How would you expect the weighted average cost of capital (WACC) to differ if you had used market values of equity rather than the book value of equity, and why?
What would you expect would happen to the cost of equity if you had to raise it by selling new equity, and why?
If the after-tax cost of debt is always less expensive than equity, why don't firms use more debt and less equity?
What are some of the advantages and disadvantages of raising capital by using debt?
How would "floatation costs" impacted the WACC, and how could they have been incorporated in the formula?

Note:You can find information about the top 500 stocks atthis Web site.

Reference no: EM13746551

Questions Cloud

Primary components of a strategic management process : Describe the primary components of a strategic management process, and indicate why a strategic management process is needed for a company

Commercial banking balance sheets : Commercial banking balance sheets. First, use a T-account to show how a $100 deposit affects the balance sheet.

What are the benefits of using an open environment : One of the most important issues concerning e-commerce is the privacy and security of one's identification and financial information. What are the benefits of using an open environment

Compare each of the three social classes including roles : discuss and compare each of the three social classes including roles, expectations, and a comparison of the living situations.

Calculating the weighted cost of capital for a firm : In this task, you will be calculating the weighted cost of capital for a firm using the book value of the components and the concepts presented in this phase.

Main premise underlying the pecking order theory : What is the main premise underlying the pecking order theory? What is the "pecking order" of sources of financing? Why is dividend policy so important to this theory? How does the concept of financials slack relate to this theory?

Develop two hypothesis : I need a valid homeland security question that can be useful in Research Design. The question has to have good references. I also have to develop two hypothesis that will help me answer the research question.

Discuss differences in election of 1832 and election of 1840 : Discuss the differences in the election of 1832 and the election of 1840.

What is point of law in different civilizations from history : What is the point of law and punishment in different civilizations from history? Select three examples and compare their motivations in using specific methods of punishment in that society.

User Account

All Pages