Question

In: Accounting

The last balance sheet of Lotus company is as follows Assets: Current Assets: 20 000 000...

The last balance sheet of Lotus company is as follows

Assets:

Current Assets: 20 000 000

Long-Term Assets: 80 000 000

Total Assets: 100 000 000

Liability and Equity

Account Payables: 4 000 000

Accrued Expenses: 1 000 000

Short-Term Loan: 15 000 000

Long Term Loan: 50 000 000

Equity as Common Stock: 30 000 000

Total Liab. and Equity: 100 000 000

This firm do not have any outstanding preferred stocks.

a) What is the total amount of financing used to finance the assets of this firm? (10 pts.)

b) What is the weight of debt and the weight of equity (common stock) in financing the assets of that firm? (20 pts.)

c) Assume that this firm has only one short term loan whose annual interest rate is 10% and only one long-term loan whose annual interest rate is 12%. What is the cost of debt for that firm if the corporate tax rate is 20% ? (20 pts)

d) This firm uses dividend discount method to find the cost of equity. What is the cost of equity if the expected dividend next year is $3 per share, if the current market value of Lotus shares is $30 per share and if firm expects an annual growth rate of 5% in future dividends? (25 pts)

e) What is the WACC (weighted average cost of capital) fort hat firm? (25 pts).

Note: You may use two or three decimals (e.g. 25.15) in your answers

Solutions

Expert Solution

Answer:-:

a.) Total amount of financing used to finance the assets of this firm:-

Short Term Loan 15000000
Long Term Loan 50000000
Equity as Common Stock 30000000
Total 95000000

b.) Weight of Debt and Equity in financing the assets of the firm:-

  • Weight of Debt = Long Term Loan+Short Term Loan/Total amount of financing used to finance the assets

= 50000000+15000000/95000000

= 68.42%

  • Weight of Equity = Equity/Total amount of financing used to finance the assets

= 30000000/95000000

= 31.58%

c.) Cost of Debt:-

Interest paid on short term loan = 15000000*10/100 = 1500000

Interest paid on long term loan = 50000000*12/100 = 6000000

Total Interest paid = 7500000

Effective Interest Rate = 7500000/65000000*100 = 11.54%

Cost of Debt (After-tax) = I(1-t) = 11.54(1-0.20) = 11.54(0.80)

= 9.23%

d.) Cost of Equity:-

Cost of Equity = D0(1+g)/P + g

where;

D0 = Dividend paid or expected to be paid = $3

g = Dividend Growth Rate = 5%

P = Market Price per share = $30

Cost of equity = 3(1+0.05)/30 + 0.05

= 3.15/30 + 0.05

= 0.105 + 0.05 = 0.155 = 15.50%

e.) WACC for the firm:-

Type Cost of Capital Weight WACC
Debt 9.23% 68.42%

6.32%

[9.23*68.42/100]
Equity 15.50% 31.58%

4.89%

[15.50*31.58/100]
Weighted Average Cost of Capital for the firm

11.21%

[6.32+4.89]

ekkarill92 answered 1 year ago
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