What is the weighted average cost of new capital

Assignment Help Accounting Basics

Reference no: EM132781975

Question - Show Solutions and explain how did they solve (Cost of Capital, Financial Leverage and Capital Structure)

Problem 1 - X Company wants to raise P20,000,000 to expand its portfolio of second mortgages and substandard auto loans. Bank financing agreements limit X Company to a maximum of 75% debt. They can borrow money at 14%, and they are in the 35% tax bracket. New retained earnings are P200,000. X Company can privately place P1,000,000 of preferred stock at 12%, and preferred floatation costs are 8.0%. Their current stock price is P20; dividends are P0.85, and have been growing at 11% per year; and flotation costs are P5 per share.

Required - Compute the weighted average cost of capital considering the following strategy.

a. What is the weighted average cost of new capital using only new retained earnings (30%) and debt (70%)?

b. What is the weighted average cost of new capital from the preferred stock offering with a blend of 25% preferred and 75% debt?

c. What is the weighted average cost of new capital maintaining a mix of 25% newly issued common stock and 75% debt?

Problem 2 - Compute the cost of capital for retained earnings of Iceland using the given information: Iceland's last dividend was P0.50 per share. Their cash flow for the last five years has been growing at a steady 12% per year. Their current stock price is P22. Their long-term bonds have a yield to maturity of 8.6%. Pinelands has a beta of 0.75. Right now, the equity risk premium is 8%, and the risk-free rate of return is 4.8%. The policy is to use a 5% judgment risk premium on any company that, like Iceland, has under $100 million in revenue.

Required - Compute the cost of new retained earnings capital using

(a) the dividend method,

(b) the CAPM method

Problem 3 - Real's capital structure consists of: (1) 20% accounts payable and other non-interest-bearing debt, (2) 45% bank debt on which they pay 10% interest, (3) 5% preferred stock, (4) 15% retained earnings, and (5) 15% stock at par plus additional paid in capital. They are in the 40% tax bracket. They have outstanding preferred stock with a P75 coupon rate for every P1,000 of par value. They have estimated their cost of common equity at 13.8%.

Required - What is their present WACC?

Problem 4 - Company Z has a bond issue outstanding that matures in fourteen years. The bonds pay interest semiannually. Currently, the bonds are quoted at 98 percent of face value and carry an 8 percent coupon. The firm's tax rate is 35 percent.

Required - What is the firm's after-tax cost of debt?

Reference no: EM132781975

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