FIN 401 Lecture 6: FIN 401 W6

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orangeminnow913

8 Jan 2018

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Financial management goal= maximize the value of the firm: Cost of capital: is the return req. /dem. by investors who provide capital for these investments cost of equity: return required by equity investors given risk of cf from the firm. Growth model (dgm) or capital asset pricing model (capm) Dgm= po = d1/re-g d1 = do * (1+g) re = d1/po + g. Capm: risk-free rate = rf, market risk premium (mrp) = e(rm) rf, Systematic risk of asset = re= rf + be (e(rm) rf) Cost of debt: return that the firm"s long-term creditors demand on borrowing. calculated by the yield-to-maturity. (solve for i) *rem. to convert if semi. Also, answer will be calculated as semi- annual, therefore, multiply ans. by 2 (annual). with debt. The firm chooses d/v = 0 while amy prefers d/v = 0. 6. To increase leverage, amy should borrow and than desired can reinvest the excess by buying extra shares.

Related Questions

Please refer to previous question I posted.

What is an appropriate required rate of return (hurdle rate) for Food Products and Instruments? How did you get it? (Hints: you may want to use the capital asset pricing model (CAPM) to estimate the cost of equity This was the answer is was given. The required rate of return or hurdle rate for Food Products and Instruments or any division or firm is the minimum rate that the firm is expected to earn while taking the project, It can generally be determined through the CAPM model: Cost of Equity = Risk free rate + Beta * Risk Premium WACC (Hurdle Rate) = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity D/E Ratios can be calculated by dividing debt to equity. The values can be taken by the firm's annual sheet or management discussions only. The value for this is available at various financial sites as well. Hurdle Rate for food products = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity = 0.6 * 2.2 + 0.4 * 4.8 = 1.32 + 1.92 = 3.24 Hurdle Rate for Instruments = D/D+E * Cost of after tax debt + E/D+E * Cost of Equity = 0.4 * 2.2 + 0.46* 9.4 = 0.88 + 5.64 = 6.52 please explain how these numbers came to be. I have worked them every way possible in my notes.

byzantiumsnail1

Question 2

If you calculated WACC for a firm, in what order (from largest to smallest) would you expect to see WACC, cost of equity (re), and cost of debt (rd)? All rates are after taxes, and assume that the firm operates at its target capital structure.

re > rd > WACC.

re > WACC > rd.

WACC > re > rd.

rd > re > WACC.

WACC > rd > re.

Question 3

Andresson Inc. has no debt, and it has two equally-sized divisions. Division A's cost of capital is 10.0%, Division B's cost is 14.0%, and the corporate (composite) WACC is 12.0%. All of Division A's projects are equally risky, as are all of Division B's projects. However, the projects of Division A are less risky than those of Division B. Which of the following projects should the firm accept?

The Division A project with a 9% return.

The Division A project with a 11% return.

The Division B project with an 11% return.

The Division B project with a 13% return.

The company-wide project with an 11% return.

Question 4

Which of the following statements is CORRECT?

A change in a company's target capital structure cannot affect its WACC.

WACC calculations should be based on the before-tax costs of all the individual capital components.

Flotation costs associated with issuing new common stock normally increase the WACC.

If a company's tax rate decreases, then, all else equal, its weighted average cost of capital will decline.

An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

Question 5

A company's perpetual preferred stock currently sells for $98.50 per share, and it pays an $7.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 8.00% of the issue price. What is the firm's cost of preferred stock?

7.72%

8.22%

8.83%

9.10%

9.40%

Question 6

O'Henry Inc. has a beta of 1.15 and a tax rate of 30%. The risk free rate of interest is 5.00%; and the market rate of return expected on equity securities is 13.00%. What is the firm's cost of common equity based on the CAPM?

11.30%

12.35%

14.20%

15.35%

17.06%

Question 7

Muller Co. just paid a dividend of $0.60 on stock that is trading at $27.50 per share. They expect a growth rate of 8.00% (constant). Flotation costs are 5%. What is the cost of common equity based on the DCF approach?

9.42%

9.91%

10.48%

10.71%

11.51%

Question 8

A company issues bonds that yield 8.75% to investors with a after-tax cost of debt of 6.1%. Economists estimate the judgmental risk premium at 8.65%. What is an estimate of the company's cost of common equity?

12.59%

13.10%

14.63%

15.60%

17.40%

greysalmon790

Eco Plastics Company: The target capital structure for ECO is given by the weights in the following table:

Source of Capital	Weight
Long-term debt	30 %
Preferred stock	20
Common stock equity	50
Total	100 %

At the present time, Eco can raise debt by selling 20 year bonds with a $1,000 par value and a 10.5% annual coupon interest rate. Eco's corporate tax rate is 40%, and its bonds generally require an average discount of $45 per bpnd and flotation costs of $32 per bond when being sold. Eco's outstanding preferred stock pays a 9 % dividend and has a $95-per-share par value. The cost of issuing and selling additional preferrerd stock is expected to be $7 per share. Because ECO is a young firm that requires lots of cash to grow it does not currently pay a dividend to common stockholders. To track the cost of common stock the CFO uses the capital asset price model (CAPM). The CFO and the firm's investment advisors believe that the appropriate risk-free rate is 4 % and that the market's expected return equals 13%. Using data from 2012 through 2015, Eco's CFO estimates the firm's beta to be 1.3. Although Eco's current target capital structure includes 20 % preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital struture to 50% long term debt and 50% common stock. If Eco shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5. A) Calculate Eco's current after-tax cost of long term debt. B) Calculate Eco's current cost of preferred stock C) Calculate Eco's current cost of common stock D) Caluclate Eco's current weighted average cost capital E (1) Assuming that the debt financing costs do not change, what effect would a shift to a more highly leveraged capital structure consisting of 50% long term debt, 0% perferred stock, and 50% common stock have on the risk premium for Eco's common stock? What would be Eco's new cost of common equity? (2) What would be Eco's new weighted average cost of capital? (3) Which capital structure-the original one or this one-seems better? Why?

FIN 401 Lecture 6: FIN 401 W6

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