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BUA321 Chapter 9 Class notes Cost of capital

BUA321 Chapter 9 Class notes Cost of capital. http://www.youtube.com/watch?feature=player_detailpage&v=JKJglPkAJ5o. Financing. Why do companies need money? Describe the differences between the capital structure and the financial structure. What are the four sources of long-term capital?.

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BUA321 Chapter 9 Class notes Cost of capital

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  1. BUA321 Chapter 9 Class notes Cost of capital

  2. http://www.youtube.com/watch?feature=player_detailpage&v=JKJglPkAJ5ohttp://www.youtube.com/watch?feature=player_detailpage&v=JKJglPkAJ5o

  3. Financing • Why do companies need money? • Describe the differences between the capital structure and the financial structure. • What are the four sources of long-term capital?

  4. Risk and financing • What is business risk? • What is financial risk? • What is the impact on the costs of financing? • What does flotation cost mean for financing?

  5. Capital structure • A company has the following capital structure: • What is the market capital structure?

  6. Cost of Debt • A company is contemplating issuing 30-year, 6% coupon bonds with a par value of $1,000. Suppose further that the firm must sell the bonds at $970. Flotation costs are 3% or $30. The corporate tax bracket is 40%. What is the cost of debt?

  7. Cost of Preferred Stock • A corporation is issuing preferred stock. The dividend will be fixed at $7.50 and sell at a price of $85. Flotation costs are $4.00. What is the cost of Preferred Stock?

  8.  Cost of Equity – RE and New CS • The corporation must raise equity. The company recently paid 4.75 in dividends. Historically dividends have grown at 8%. The company anticipates that this will continue. The most recent price for the stock has been $87. Flotation costs have been $2, but the company anticipates an additional $2 in underpricing. The risk free return is 3.75; beta is 1.25; and the stock market average is 11%. What is average cost of retained earnings? The cost of new Common Stock?

  9. Marginal Cost of Capital • The company has determined that they can borrow up to $40 million before the cost of debt would increase to 7.5% before taxes. The company forecasts that next year they will have approximately $20 million in retained earnings. Determine the marginal costs of capital for the firm.

  10.  Small business financing http://www.youtube.com/watch?feature=player_detailpage&v=31ZwhL4pgJw

  11. BUA321 Chapter 9 research 25 points • Using your company what is the market value capital structure? Use the book value of debt as the market value. • From the stock valuation chapter, what is the dividend and SML cost of retained earnings? • Assume a $5 flotation cost for new equity. What is the cost of new equity? • Predict a 5% increase in revenues next year. Given this forecast, what is your predicted retained earnings next year? Use this for the break point of equity costs. • What is the WMCC for the firm?

  12.  BUA321 Exercise 33 points • Complete the following table: The current corporate tax rate is 40%.

  13. Complete the following table for costs of financing The current corporate tax rate is 40%. (6 points)

  14. Complete the following table The current corporate tax rate is 40%. (9 points)

  15. WACC • Using the securities above calculate the WACC for the following companies. • Company A finances its cash needs with 30% debt, 40% preferred stock, and 30% equity. • WACC with RE • WACC with new common stock

  16. Company B finances its cash needs with 60% debt, 10% preferred stock, and 30% equity. • WACC with RE • WACC with new common stock

  17. Company C finances its cash needs with 20% debt, 5% preferred stock, and 75% equity. • WACC with RE • WACC with new common stock

  18. Complete the following comprehensive cost of capital problem. • Debt – The company is issuing 150,000 AAA rated bonds for $975. The bonds have a 30 year maturity and a 6.75% coupon. The average flotation costs for bonds is $10. The company’s corporate tax rate is 40%. If the company were to need $200,000,000 of debt the after-tax cost of financing would increase 2%. • Preferred stock will be issued with a 5.25% dividend and a stock price of $85. The company is considering issuing 600,000 shares. The flotation costs are estimated to be $2. There is no additional increase in costs if the firm decides to issue more preferred. • New common stock will be issued with a projected dividend of $3.75. The current stock price is $120. The company’s earnings and dividends have been growing historically at 6% The company is estimating that 2,000,000 shares will be issued with a $1 underpricing cost and a $2 underwriting fee. Retained earnings are expected to be $500,000,000.

  19. Calculations • What is the after-tax cost of debt? • What is the after-tax cost of preferred? • What is the cost of retained earnings? • What is the cost of new common equity? • What is the capital structure of the financing? (what are the proportions?) • What is the break point of debt? • What is the breakpoint of equity? • Calculate the WMCC at the breakpoints.

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