An unlevered firm has a cost of capital of 13.6 percent and earnings before interest and taxes of $138,000. A levered firm with the same operations and assets has both a book value and a face value of debt of $520,000 with an annual coupon of 7 percent. The applicable tax rate is 21 percent. What is the value of the levered firm?
In: Finance
A firm’s weighted average cost of capital (WACC) is used as the discount rate to evaluate various capital budgeting projects. However, remember the WACC is an appropriate discount rate only for a project of average risk.
Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address.
Consider the case of Fuzzy Button Clothing Company
Fuzzy Button Clothing Company has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 11.1%, and its cost of preferred stock is 12.2%.
If Fuzzy Button can raise all of its equity capital from retained earnings, its cost of common equity will be 14.7%. However, if it is necessary to raise new common equity, it will carry a cost of 16.8%.
If its current tax rate is 40%, how much higher will Fuzzy Button’s weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Round your answer to two decimal places.)
0.83%
0.98%
0.75%
1.01%
Consider the case of Peaceful Book Binding Company
he CFO of Peaceful Book Binding Company is trying to determine the company’s WACC. He has determined that the company’s before-tax cost of debt is 9.60%. The company currently has $750,000 of debt, and the CFO believes that the book value of the company’s debt is a good approximation for the market value of the company’s debt.
| • | The firm’s cost of preferred stock is 10.70%, and the book value of preferred stock is $45,000. |
| • | Its cost of equity is 13.50%, and the company currently has $500,000 of common equity on its balance sheet. |
| • | The CFO has estimated that the firm’s market value of preferred stock is $78,000, and the market value of its common equity is $880,000. |
If PBBC is subject to a tax rate of 40%, Peaceful Book Binding Company’s WACC is ______.
Consider the case of Chilly Moose Fruit Producer
Chilly Moose Fruit Producer is considering a new project that will require an initial investment of $4 million. It has a target capital structure of 35% debt, 2% preferred stock, and 63% common equity. Chilly Moose Fruit has noncallable bonds outstanding that mature in 15 years with a face value of $1,000, an annual coupon rate of 11%, and a market price of $1,555.38. The yield on the company’s current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell new shares of preferred stock that pay an annual dividend of $8 at a price of $95.70 per share. Assume that Chilly Moose Fruit new preferred shares can be sold without incurring flotation costs.
Chilly Moose Fruit does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and it is expected to pay a dividend of $2.78 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 40%.
Chilly Moose Fruit’s WACC for this project will be: (Note: Round your answer to two decimal places.)
18.38%
15.32%
12.26%
14.55%
In: Finance
You expect that you will need to replace your furnace in 4 years at a cost of $15,067. How
much must you save today in an account that pays 3.18% APR (compounded monthly) to exactly pay the $15,067 in 4 years?
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Third State Bank wants to add a new branch office. It has determined that the cost of construction of the new facility will be $1.5 million with another $500,000 in organizational costs. The bank has estimated that it will generate $319,522 per year in net revenues for 20 years. If Third State requires a 17% return on its money, what is this project's net present value?
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Figures are in millions of dollars
| Net sales | $ | 2,473.8 |
| Cost of goods sold (COGS) | $ | 1,316.2 |
| Operating expenses (S&GA) | $ | 575.8 |
| Inventory | $ | 250.1 |
| Accounts receivable | $ | 36.7 |
| Other current assets | $ | 68.9 |
| Fixed assets | $ | 690.0 |
What's the net profit margin? $____ Show work.
What's the net profit margin %? _____ Show work.
What's the value of total assets? $____ Show work.
What's the asset turnover ? $____ Show work.
What's the return on assets (ROA)? $____ Show work.
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State TWO (2) factors that differentiate between the Rate of Return and Cost of Capital.
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Daily Enterprises is purchasing a $10.3 million machine. It will cost $47,000 to transport and install the machine. The machine has a depreciable life of five years and will have no salvage value. The machine will generate incremental revenues of $4.2 million per year along with incremental costs of $1.1 million per year. If Daily's marginal tax rate is 35% what are the incremental earnings (net income) associated with the new machine?
The annual incremental earnings is what ? $ (Round to the nearest dollar.)
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The COFD (Cost of farm debt) will always be smaller when done on a market basis than on a cost basis? Why or why not?
What can a farm do to increase ROFE? Explain.
ROFE > ROFA > COFD. Is this a positive or negative use of leverage? Explain
Why does a firm need liquidity?
Can a firm be liquid and not solvent? Or vice versa? Explain
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Frankenstein Bicycles has an unlevered cost of equity of 0.15. Their bonds are worth 435,721 and their equity is worth 323,527. The debt rate is 0.02 and their tax rate is 0.22. What is Frankenstein's cost of levered equity?
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A project is expected to cost $85096 up front, and then return $23768 in year 1, $45414 in year 2, and $32710 in year 3. If the company demands a 8% return from their projects, what is the net present value of this project? Answers should be to the nearest cent. If your answer is negative please write it as "$-100.03" with the dollar sign before the negative so blackboard can read it correctly.
In: Finance