Assingment 7

In: Business and Management

Submitted By ihoyte1
Words 776
Pages 4
The firm's tax rate is 40%. The current price of the 12% coupon, semiannual payment, non-callable bonds with 15 years to maturity is $1,153.72. New bonds could be issued with no flotation costs. The current price of the firm's 10% $100 par value, quarterly dividend, perpetual preferred stock is $116.95. The flotation costs on a new issue would be 5% of the proceeds.
4. The current price of the common stock is $50 per share. The last dividend was $4.19, and dividends are expected to grow at a constant rate of 5%. The firm's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is 6%.
5. The target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.

Procedure
1. What sources of capital should be included when you estimate XYZ's WACC? The WACC is used primarily for making long-term capital investment decisions, I.E., for capital budgeting. Thus, the WACC should include the types of capital used to pay for long-term assets, and this is typically long-term debt, preferred stock (if used), and common stock. Short-term sources of capital consist of (1) spontaneous, noninterest-bearing liabilities such as accounts payable and accruals and (2) short-term interest-bearing debt, such as notes payable. If the firm uses short-term interest-bearing debt to acquire fixed assets rather than just to finance working capital needs, then the wacc should include a short-term debt component. Noninterest bearing debt is generally not included in the cost of capital estimate because these funds are netted out when determining investment needs, that is, net operating rather than gross operating working capital is included in capital expenditures.

2. Should the component costs be estimated on a before or after-tax basis? Why? Stockholders are concerned primarily with those corporate cash flows that are available for their…...

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