PART 4 Long-Term Financial Decisions CHAPTERS IN THIS PART 11 12 13 The Cost of Capital Leverage and Capital Structure Dividend Policy INTEGRATIVE CASE 4 O’GRADY APPAREL COMPANY CHAPTER 11 The Cost of Capital INSTRUCTOR’S RESOURCES Overview This chapter introduces the student to an important financial concept‚ the cost of capital. The mechanics of computing the sources of capital-debt‚ preferred stock‚ common stock‚ and retained earnings are reviewed. The relationship between
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term lasting for 10-30 years. Levered β @ target D/E ratio Ratio=42.2% The target ratio defines the target D/E that the company requires to reach for the credit rating to be applicable. E&P Weighted Average Cost of Capital‚ rE&P-wacc Division wise WACC is essential as each business line has different risk-return profile. Since individual divisional stocks are not traded in the market‚ β for E&P has been calculated by revenue based weighted average of pure-play E&P companies. However it
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increasing shareholder value‚ optimizing the use of debt‚ and repurchasing their undervalued shares. Marriott Corporation relied on measuring the opportunity cost of capital for investments by utilizing the concept of Weighted Average Cost of Capital (WACC). In April 1988‚ VP of project finance‚ Dan Cohrs suggested that the divisional hurdle rates at the company would have a key impact on their future financial and operating strategies. Marriott intended to continue its growth at a fast pace by relying
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Fin 3010 Dr. Michello Summer 2007 Practice Problems Expected dividend yield Answer: a EASY i. If D1 = $2.00‚ g (which is constant) = 6%‚ and P0 = $40‚ what is the stock’s expected dividend yield for the coming year? a. 5.0% b. 6.0% c. 7.0% d. 8.0% e. 9.0% Expected return‚ dividend yield‚ and capital gains yield Answer: e EASY ii. If D1 = $2.00‚ g (which is constant) = 6%‚ and P0 = $40‚ what is the stock’s expected capital gains yield for the coming year? a. 5.2% b. 5.4%
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are BEA’s new beta and cost of equity if it has 40% debt? - BEA’s new beta βL = βLใหม่ = (0.87) βLใหม่ = 1.218 - BEA’s cost of equity RsL = RF + βL(RM - RF) = 6% + (1.218)(4%) = 10.872% c. What are BEA’s WACC and total value of the firm with 40% debt? - BEA’s WACC WACC = = (9%)(1-0.4)(0.4) + (10.872%)(0.6) = 8.683% - BEA’s total value of the firm V0 of firm = ‚ g = 0% = = = = $103‚188‚000 Problems (26-9) International Associates (IA) is about to commence operations
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broke. Question #5 How does WACC change over time? What do you think might drive the changes? WACC is the opportunity cost of investing in a company‚ or the expected return of shareholders and debt holders. WACC consists of all capital sources and includes common stock‚ preferred stock‚ short-term debt and long-term debt in the calculation. WACC is the average costs of capital financing‚ and tells us how much a company has to pay for each dollar of financing. WACC for any company will fluctuate
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Once funded‚ a project/investment’s performance was measure in two ways. The first being actual performance vs forecasted plan over 1‚ 3‚ and 5 year periods‚ and the second being Economic Value Added (EVA). EVA was calculated as: EVA = EBIT(1-t) – WACC(period capital expenditure) Midland Energy Capital Planning Model • Optimize capital structure • Midland primarily optimized its capital structure by taking advantage of the borrowing capacity inherent in its energy reserves and long term assets
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Percentage of; Calculation Weight by % Bonds Additional bond 50 million / 1‚120 million 45 million / 1‚120 million 4.46 4.02 Preferred stock 1‚000 million / 1‚120 million 89.29 Common stock 25 million / 1‚120 million 2.23 Total 100 iv) New WACC calculation WACC = (% of debt) (After-tax cost of debt) + (% of preferred stock) (cost of preferred stock) + (% of common stock) (cost of common
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while PepsiCo’s EVA has been increasing (see Exhibit 1.1). Coca-Cola’s NOPAT has decreased in recent years as a result of slowing sales growth and worsening profit margins. If it were not for Coca-Cola’s decreasing WACC‚ its EVA would decrease more rapidly. If Coca-Cola used a WACC of 12%‚ about the average of the past seven years‚ its EVA would have been $445‚000‚000 in 2000. PepsiCo was able to more than double their EVA in
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practice problems Questions 1. What does the WACC measure? 2. Which is easier to calculate directly‚ the expected rate of return on the assets of a firm or the expected rate of return on the firm’s debt and equity? Assume you are an outsider to the firm. 3. Why are market-based weights important? 4. Why is the coupon rate of existing debt irrelevant for finding the cost of debt capital? 5. Under what assumptions can the WACC be used to value a project? 6. How should
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