Question

In: Finance

Empire Today Inc. has 10 million shares of common stock outstanding, 300,000 shares of 5% preferred...

Empire Today Inc. has 10 million shares of common stock outstanding, 300,000 shares of 5% preferred stock outstanding, and 7 million of 6.7 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $85 per share and has a beta of 1.15, the preferred stock currently sells for $103 per share, and the bonds have 20 years to maturity and sell for 93% of par. The market risk premium is 11 percent, T-bills are yielding 2.14 %, and the firm's tax rate is 25.7%.

Calculate costs of Empire’s common stock, preferred stock, and debt, then explain your problem solving step-by-step.

Calculate the firm’s Weighted Average Cost of Capital and explain the meaning of WACC using your calculated solution. Show step by step

The CFO is assessing a potential project which will yield an IRR of 9.3%. The project has the firm level risk. Should the CFO accept the project?

Solutions

Expert Solution

Answer 1:

Using CAPM model:

Costs of Empire’s common stock = Risk free rate + Beta * Market risk premium

= 2.14% + 1.15 * 11%

= 14.79%

Costs of Empire’s common stock = 14.79%

Costs of preferred stock = Annual dividend / Current price = 100 * 5% / 103 = 4.854%

Costs of preferred stock = 4.854%

Cost of debt:

Bond face value = $1,000

Semiannual coupon = 1000 * 6.7% / 2= $33.50

Time to maturity = 20 years = 40 semiannual periods

Current price = 1000 * 93% = $930

Semiannual yield = RATE (nper, pmt, pv, fv, type) = RATE (40, 33.50, -930, 1000, 0) = 3.6874%

Cost of debt =3.6874% * 2 = 7.375%

Cost of debt = 7.375%

Answer 2:

To calculate WACC, first let us calculate market values of each of capital components.

WACC = Cost of equity * weight of equity + Cost of preferred stock * weight of preferred stock + Cost of debt * (1 - Tax rate) * weight of debt

= 14.79% * 850 / 7390.9 + 4.854% * 30.9 /7390.9 + 7.375% * (1 - 25.7%) * 6510 /7390.9

= 6.55%

WACC = 6.55%

As firm's capital consists of various components and each has different costs and tax treatment, it is essential to calculate weighted average cost of capital for it to be used to evaluate any investment proposition and decide whether to accept such proposition or not.

Answer 3:

Yes,

CFO should accept the project

As we calculated above WACC = 6.55%

The CFO is assessing a potential project which will yield an IRR of 9.3%.

Since IRR is higher than WACC, the potential project should be accepted.

jeff jeffy answered 10 months ago
Next > < Previous

Related Solutions

Fairyland Inc. has 4 million shares of common stock outstanding, 1 million shares of preferred stock...
Fairyland Inc. has 4 million shares of common stock outstanding, 1 million shares of preferred stock outstanding, and 200 thousand bonds. The common shares are selling for $25 per share, the preferred share are selling for $10 per share, and the bonds are selling for 95 percent of their $1,000 par. (See P10-3 for formula to calculate weights). A. What would be the weight used for equity in the computation of FarCry’s WACC? B. What weight should you use for...
Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred...
Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1,000 each. The preferred stock pays a dividend of $6 per share. The common stock currently sells for $32 per share and has a beta of 1.15, the preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par....
Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred...
Titan Mining Corporation has 8 million shares of common stock outstanding, 5 million shares of preferred stock outstanding, and 100,000 units of 9 percent semiannual bonds outstanding, par value $1,000 each. The preferred stock pays a dividend of $6 per share. The common stock currently sells for $32 per share and has a beta of 1.15, the preferred stock currently sells for $67 per share, and the bonds have 15 years to maturity and sell for 91 percent of par....
Google currently has a 5 million common shares outstanding, and a 1 million preferred shares outstanding,...
Google currently has a 5 million common shares outstanding, and a 1 million preferred shares outstanding, and 100,000 bonds outstanding. Calculate Google Weighted Average Cost of Capital (WACC) if the corporate tax rate is 35%. (Using excel and making formulas viewable) The average cost of equity of Google is 19.04%. The cost of Google’s preferred stocks if it is currently priced at $100 is 6%. The pre-tax cost of debt of Google is 6.85%.​​​​​​​
(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common...
(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common stock is valued at $10 per share, with 2 million shares outstanding. It has a beta of 5, and market return is estimated to be 4% while treasury bills offer 1.5% risk-free rate. The preferred stock is valued at $15 per share, which pays dividend of $2 each year at a constant growth rate of 3%. Preferred stocks have 5 million shares outstanding. Finally,...
(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common...
(WACC) A company has common stock, preferred shares, and debt outstanding. As of today, the common stock is valued at $10 per share, with 2 million shares outstanding. It has a beta of 5, and market return is estimated to be 4% while treasury bills offer 1.5% risk-free rate. The preferred stock is valued at $15 per share, which pays dividend of $2 each year at a constant growth rate of 3%. Preferred stocks have 5 million shares outstanding. Finally,...
Solar Shades has 8.8 million shares of common stock outstanding, 4.8 million shares of preferred stock...
Solar Shades has 8.8 million shares of common stock outstanding, 4.8 million shares of preferred stock outstanding, and 18 thousand bonds. If the common shares are selling for $13.80 per share, the preferred share are selling for $30.80 per share, and the bonds are selling for 104.92 percent of par, what would be the weight used for equity in the computation of Solar Shade's WACC?
Sports Corp has 11.8 million shares of common stock outstanding, 6.8 million shares of preferred stock...
Sports Corp has 11.8 million shares of common stock outstanding, 6.8 million shares of preferred stock outstanding, and 2.8 million bonds. If the common shares are selling for $26.8 per share, the preferred share are selling for $14.3 per share, and the bonds are selling for 96.82 percent of par, what would be the weight used for equity in the computation of Sports's WACC?
Town Beverage has 8 million shares of common stock outstanding, 6 million shares of preferred stock...
Town Beverage has 8 million shares of common stock outstanding, 6 million shares of preferred stock outstanding, and 5 thousand bonds. If the common shares are selling for $20 per share, the preferred shares are selling for $10 per share, and the bonds are selling for 105 percent of par, what would be the weight used for preferred stock in the computation of Town Beverage's WACC? A. 26.64% B. 27.27% C. 29.85% D. 33.33% E. 42.84% Echo Sound has 4...
Bluefield Corporation has 6 million shares of common stock outstanding, 600,000 shares of preferred stock that...
Bluefield Corporation has 6 million shares of common stock outstanding, 600,000 shares of preferred stock that pays an annual dividend of $8, and 200,000 bonds with a 10 percent coupon (semiannual interest) and 20 years to maturity. At present, the common stock is selling for $50 per share, the bonds are selling for $950.62 per $1,000 of face value, and the preferred stock is selling at $74 per share. The estimated required rate of return on the market is 13...
ADVERTISEMENT
Subjects
ADVERTISEMENT
Latest Questions
ADVERTISEMENT