#1 During the past few years, Super Technologies has been too…
Question Answered step-by-step #1 During the past few years, Super Technologies has been too… #1 During the past few years, Super Technologies has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. As the assistant to the financial vice-president, it is your task is to estimate Super’s weighted average cost of capital (WACC). The VP has provided you with the following information: 1. The firms’ tax rate is 40%. 2. The current market price of Super’s outstanding bonds is $1,153.72. The bonds have an annual coupon rate of 12% and make coupon payments semiannually. The bonds mature in 15 years and have a par value of $1,000. 3. The current price of the firm’s preferred stock is $113.10 per share. The stock has a $100 par value and a 10% annual dividend rate (paid annually). 4. The current price of the firm’s common stock is $50 per share. Its last dividend was D0 = $4.19 per share. Dividends are paid semiannually and are expected to grow at an annual rate of 5% into the foreseeable future. 2020 Balance Sheet (thousands of dollars)cash 102 accounts payable 325accounts receivable 400 notes payable 300inventory 438 accruals 110 current assets 940 current liabilities 735gross fixed assets 2550 long-term debt (bonds) 500accum. depreciation 550 preferred stock 250 net fixed assets 2000 common stock 125 total assets 2940 paid-in capital 650 retained earnings 680 total common equity 1455 total liabilities and equity 2940 FormulaThe formula for Weighted Average Cost of Capital (WACC) is: WACC = wdrd(1-T) + wpsrps + wcerce where wd, wps, wce are the weights of each type of capitalT is the company’s effective tax raterd is the cost of long-term debt (bonds)rps is the cost of preferred stockrce is the cost of common equity. CalculationsStep 1. Calculate the weightsEach weight is the percentage of total capital represented by its capital category (i.e., bonds, preferred stock, and common equity). Using recent balance sheet information, find total capital by adding up the amounts in the five capital accounts (long-term debt, preferred stock, common stock, paid-in capital, retained earnings). Using that balance sheet information: wd = (amount of long-term debt) / (total capital) wps = (amount of preferred stock) / (total capital) wce = (common stock + paid-in capital + retained earnings) / (total capital). NOTE…………the three weights must add up to 100% or 1. Step 2. Calculate the cost of debtThe cost of debt is represented by the yield-to-maturity of the company’s bonds. Yield-to-maturity is calculated as: FV = par value PMT = semiannual coupon payment N = number of semiannual payment periods PV = – current market price CPT I/Y this is the semiannual cost of debt. NOTE……………remember to adjust the cost of debt to annual terms. Step 3. Calculate the cost of preferred stockThe dividends of preferred stock are a constant perpetuity. The cost of preferred stock is: rps = dividend current market price NOTE……………remember to adjust the cost of preferred stock to annual terms. Step 4. Calculate the cost of common equityRecall that common equity is made up of three capital accounts – common stock, paid-in capital, retained earnings. All of this capital is provided, in one way or another, by the company’s common stockholders. So, the cost of common equity is calculated in the same way as the return on common stock. The specific calculation will depend upon whether the common stock regularly pays dividends. Step 4A. If the common stock pays dividends, then we will make the assumption that the common stock is a growing perpetuity. Therefore, the cost of common equity is: rce = D1 _____ + g current market price Where D1 is the upcoming dividendg is the growth rate of dividends. Sometimes, you will know how much D1 is expected to be. Other times, you may only know the previous dividend (D0) and will have to calculate D1. In this case, D1 is D0 plus one period’s growth:D1 = D0 + (D0)(g) = (D0)( 1+g). NOTE………………remember to keep everything in terms of the same compounding (annual, semiannual, quarterly) AND always adjust your final answer to annual terms. Step 4B. If the common stock does not pay dividends, then we will use the Capital Asset Pricing Model (CAPM). The general form of CAPM is: E(Ri) = Rf + [ E(RM) – Rf ] ?i Where E(Ri) is the expected return on the individual stock Rf is the return on a stock with zero risk E(RM) is the expected return on the market overall ?i is the beta of the individual stock. Step 5. Calculate the WACCUse your answers from 1, 2, 3, and 4 for WACC formula. Your answer is an annual percent. Business Finance FIN 3213 Share QuestionEmailCopy link Comments (0)
