Question

Exhibit 1

Flight Plan Consulting, Inc.

Sales and Earnings Trend

Year	Sales		Net Income After-Tax	EPS
1992	$2,000,000		$240,000	$0.60
1993	2,750,000		338,000	0.84
1994	3,200,000		384,000	0.96
1995	5,000,000		575,000	1.44
1996	5,700,000		600,000	1.50
1997	6,200,000		713,000	1.78
1998	7,300,000		803,000	2.00
1999	8,500,000		860,000	2.15
2000	9,100,000		900,000	2.25
2001	10,300,000		912,720	2.28

Exhibit 2

Flight Plan Consulting, Inc.

Balance Sheet

December 31, 2001

($000’s)

Current Assets	$1,500		Current Liabilities	$400
Fixed Assets	1,500		Long-Term Debt	600
			Common Stock ($1 par value)	400
			Retained Earnings	1,600
Total Assets	$3,000		Total Lia. & Equity	$3,000

Exhibit 3

Flight Plan Consulting

Selected Capital Market & Industry Data [1]

Yield on AAA Corporate Debt	6%
Yield on 10-year US-Government Bonds	5.1%
Historical (10-year) return on a broad market average of common stock	16%
Dividend Payout Ratio of a sample of 10 specialized consulting firms	25%

[1] The long-term debt on FPC’s balance sheet carried a coupon rate of 7% and will mature in 5 years. The firm was in the 30% (combined) tax bracket, and had a dividend payout ratio of 30%. The present market price of the firm’s common stock is $18.

What are FPC's historical (book) costs of debt and equity?

What is FPC's historical weighted average cost of capital (WACC)?

Answer 1

Cost of debt of any company is after-tax applicable interest rate as interest payments are tax deductible creating a tax-shield and hence, the tax-shield should be taken into account while determining cost of debt.

Formula: Cost of Debt = Interest rate * (1-tax rate)

Cost of debt for Flight-Plan Consulting = 7% * (1-30%)
=> 7% * 0.70 = 4.90%

Cost of equity refers to the required rate of return that common investors expect from a company considering its riskiness as investors share the risk of a firm when they invest their money into the firm and hence, they should be compensated for the extra risk they take.

In the given situation, we are supplied with dividend pay-out ratio and current market price of share. So, we will use the below formula:

Cost of Equity = [(Dividend per share/Current market value of stock) + growth rate of dividends]

As per the information given, the company’s dividend pay-out ratio is 30%, current earnings per share are $2.28 and the current market price of the firm’s common stock is $18. The growth rate of dividend comes out at 32% (= ROE x (1-Dividend Pay-out Ratio)

Cost of equity for Flight-Plan Consulting = {(2.28 x 30%)/18} + 32%

= 0.038 + 32%

Cost of equity = 32.038%

Weighted Average Cost of Capital refers to the cost of capital that a firm pays for its capital. It is calculated by below given formula:

WACC = (Weight of Equity x Cost of Equity) + (Weight of Debt x Cost of Debt)

Weight of Equity = Total Equity / Total Capital
=> $2,000,000 /$3,000,000 = 0.66667

Weight of Debt = 1- Weight of Debt
=> 1 – 0.66667 = 0.333333

WACC = (0.32038 * 0.66667) + (0.049 * 0.3333333) = 0.22992 or 22.992%