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Assignment 2 FM

This document provides information on the capital structure, stock price, dividend, growth rate, tax rate, and flotation costs of Xerox Company. It asks to calculate the weighted average cost of capital (WACC). It also provides balance sheet information and other financial details on Amshore Company and asks to calculate the market value of long term debt, weight of common equity, and WACC. Further questions ask to analyze machine replacement decisions, estimate cost of common equity, and calculate WACC based on a company's capital structure information.

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Syeda Fizza Rizvi
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124 views

Assignment 2 FM

This document provides information on the capital structure, stock price, dividend, growth rate, tax rate, and flotation costs of Xerox Company. It asks to calculate the weighted average cost of capital (WACC). It also provides balance sheet information and other financial details on Amshore Company and asks to calculate the market value of long term debt, weight of common equity, and WACC. Further questions ask to analyze machine replacement decisions, estimate cost of common equity, and calculate WACC based on a company's capital structure information.

Uploaded by

Syeda Fizza Rizvi
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Q1.

An analyst has collected the following information regarding Xerox Company:

 The company’s capital structure is 70 percent equity and 30 percent debt.


 The yield to maturity on the company’s bonds is 9 percent.
 The company’s year-end dividend is forecasted to be $0.80 a share.
 The company expects that its dividend will grow at a constant rate of 9 percent a year.
 The company’s stock price is $25.
 The company’s tax rate is 40 percent.
 The company anticipates that it will need to raise new common stock this year. Its
investment bankers anticipate that the total flotation cost will equal 10 percent of the
amount issued. Assume the company accounts for flotation cost by adjusting the cost of
capital.

Required: Calculate the Weighted Average Cost of Capital (WACC)

Q2. Balance Sheet of Amshore Company is as under:

Current Assets $45,000,000 Notes Payable $15,000,000


Fixed Assets 75,000,000 Long term Debt 45,000,000
Common Equity:
Common Stock (1.5m shares) 1,500,000
Retained Earnings 58,500,000
Total Assets $120,000,000 Total Liabilities & Equity $120,000,000

The interest rate on notes payable is 10%, the same as new bank loans. The long term debt
consists of 45,000 bonds with 20 years to maturity. Each bond has a par value of $1,000 and an
annual coupon rate of 6%. The going rate of interest on new long term debt of similar risk and
maturity is 10%. The common stock is trading at $30 per share and cost of equity is 15%

Required:
a. what is the market value of the firm’s long term debt?
b. What is the market value weight of common equity in the firm’s capital structure if short–term
debt is included?
c. What is the weighted average cost of capital (WACC)?

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Q3. The ExxonMobil Company purchased a machine 5 years ago at a cost of $90,000. The
machine had an expected life of 10 years at the time of purchase, and it is being depreciated by
the straight-line method by $9,000 per year. If the machine is not replaced, it can be sold for
$10,000 at the end of its useful life.
A new machine can be purchased for $150,000, including installation costs. During its 5-year
life, it will reduce cash operating expenses by $50,000 per year. Sales are not expected to
change. At the end of its useful life, the machine is estimated to be worthless. MACRS
depreciation will be used, and the machine will be depreciated over its 3-year class life rather
than its 5-year economic life, so the applicable depreciation rates are 33%, 45%, 15%, and 7%.
The old machine can be sold today for $55,000. The firm’s tax rate is 35%, and the appropriate
WACC is 16%.

Q4. The CFO of Lenox Industries hired you as a consultant to help estimate its cost of common equity.
You have obtained the following data:
(1) rd = yield on the firm’s bonds = 7.00% and the risk premium over its own debt cost = 4.00%.
(2) rRF = 5.00%, RPM = 6.00%, and b = 1.25.
(3) D1 = $1.20, P0 = $35.00, and g = 8.00% (constant).
You were asked to estimate the cost of common based on the three most commonly used methods and
then to indicate the difference between the highest and lowest of these estimates. What is that difference?
Q5. Assume that you have been hired as a consultant by CGT, a major producer of chemicals and
plastics, including plastic grocery bags, styrofoam cups, and fertilizers, to estimate the firm's weighted
average cost of capital. The balance sheet and some other information are provided below.

Assets
Current assets $ 38,000,000
Net plant, property, and equipment 101,000,000
Total assets $139,000,000

Liabilities and Equity


Accounts payable $ 10,000,000
Accruals 9,000,000
Current liabilities $ 19,000,000
Long-term debt (40,000 bonds, $1,000 par value) 40,000,000
Total liabilities $ 59,000,000

Common stock (10,000,000 shares) 30,000,000


Retained earnings 50,000,000
Total shareholders' equity 80,000,000

Total liabilities and shareholders' equity $139,000,000

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The stock is currently selling for $15.25 per share, and its non-callable $1,000 par value, 20-year, 7.25%
bonds with semiannual payments are selling for $875.00. The beta is 1.25, the yield on a 6-month
Treasury bill is 3.50%, and the yield on a 20-year Treasury bond is 5.50%. The required return on the
stock market is 11.50%, but the market has had an average annual return of 14.50% during the past 5
years. The firm's tax rate is 40%.
Instructions:

a. What is the best estimate of the after-tax cost of debt?


b. Based on the CAPM, what is the firm's cost of common stock?
c. Which of the following is the best estimate for the weight of debt for use in
calculating the firm’s WACC?
d. What is the best estimate of the firm's WACC?

Q6. On January1, the total market value of the Shoon Enterprises was $20 million. During the year, the
company plans to raise and invest $10 million in new projects. The firm’s present market value capital
structure, shown below, is considered to be optimal. Assume there is no short-term debt.
Debt $10,000,000
Common equitiy 10,000,000
Total $20,000,000
New 30-year bonds will have a 7% stated rate, are discounted $59.36 for each $1,000 par value bond
when issued, and pay interest semi-annually. Stockholder’s required rate of return is consists of a 5%
dividend yield to the investor based on the next dividend paid out of $1.25 a share, and an expected
constant growth rate of 8%. Flotation costs to the issuer are $2 a share. The marginal corporate tax rate is
40%.
Instructions:
a. To maintain the present capital structure, how much of the new investment (in millions)
must be financed by common equity.
b. What is the net price per share to the company if they use external equity and issue stock
to finance the business? How many new shares must be issued?
c. Now assume what there is sufficient cash flow so that the Shoon Enterprises can maintain
its target capital structure without issuing additional shares of equity, what is the WACC?

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