Question

In this paper, please discuss the following case study. In doing so, explain your approach to the problem, support your approach with references, and execute your approach. Provide an answer to the case study’s question with a recommendation.

Case Study:

The Comic Book Publication Group (CBPG) specializes in creating, illustrating, writing, and printing various publications. It is a small but publicly traded corporation. CBPG currently has a capital structure of $12 million in bonds that pay a 5% coupon, $5 million in preferred stock with a par value of $35 per share and an annual dividend of $1.75 per share. The company has common stock with a book value of $6 million. The cost of capital associated with the common stock is 10%. The marginal tax rate for the firm is 33%.

The management of the company wishes to acquire additional capital for operations purposes. The chief executive officer (CEO) and chief financial officer (CFO) agree that another public debt offering (corporate bonds) in the amount of $10 million would suffice. They believe that due to favorable interest rates, the company could issue the bonds at par with a 4% coupon.

Before the Board of Directors convenes to discuss the debt Initial Public Offering (IPO), the CFO wants to provide some data for the board of directors’ meeting notebooks. One point of the analysis is to evaluate the debt offering’s impact on the company’s cost of capital. To do this:

• Solve for the current cost of capital of CBPG on a weighted average basis
• Solve for the new cost of capital, assuming the $10 million bond issued at par with a 4% coupon.
• Describe how you approached these calculations. Also discuss the tax shield advantage that debt capital provides, and briefly explain the cost of capital and WACC
• Provide a Table(s) to present answers (Students can transfer their EXCEL Table if utilized)

Summarize findings

Superior papers will explain the following elements when responding to the assignment questions:

• Provide narrative and solve for the current cost of capital of CBPG on a weighted average basis (WACC)
• Provide narrative and solve for the new cost of capital (WACC)
• Provide accurate WACC calculations for both scenarios
• Provide a Table(s) to present answers (there is a difference between performing calculations and presenting the supporting data and solved answers)
• Provide narrative on tax shield implications for both scenarios
• Provide narrative briefly explaining the cost of capital and WACC
• Provide a clear, logical conclusion

Answer 1

1
Cost of Bonds= Interest Cost (1- tax rate)
Cost of Bonds= 5%(1-0.33)
	= 5(0.67)
	= 3.35 %
Cost of Peference Shares= Dividend Paid/ Par value of Pref Shares
Cost of Peference Shares= 1.75/35
Cost of Peference Shares= 5%
Cost of Equity= 10% (Given)
Exsting WACC
Source of Capital	Amount of Capital (MM)	Cost of Capital
Bonds	12	3.33
Preferred Stock	5	5
Stock	6	10
Total	23
WACC= Total Cost / Total Capital
WACC= (12*3.33%)+ (5*5%)+(6*10%)/23
WACC= 5.43%
2. Revised Cost of Capital after additional debt sourcing
Cost of New Debt= 4% (1-0.33)
Cost of New Debt= 2.67%
Revised WACC= (12*3.33%)+ (5*5%)+(6*10%)+ (10*2.67%)/33
Revised WACC= (0.4+0.6+0.25+0.26)/33
Revised WACC= 4.60%
3. Conclusions
In the two cases, Cost of Capital decreases as CBPG were able to source fresh debt 2.67%
which was below the original cost of total capital of 5.43%.
The tax advantage associated with Debt Capital further reduces the cost of debt as any
interest paid on debt is an allowable deduction for calculation of taxable profits and on
that portion taxes to paid reduces.