As a consultant to GBH skiwear, you have been ask to compute the appropriate dis
ID: 2650744 • Letter: A
Question
As a consultant to GBH skiwear, you have been ask to compute the appropriate discount rate to use to evalute thepurchase of a new warehouse facility. You have determined the market value of the firm's capital structure as follows:
To finance the pruchase, GBH will sell 20 year bonds with a $1,000 par value paying 7.8 percent per year, at the market price of $965. Preferred stock paying a $2.59 divodend can be sold for $34.55. Common stock for GBH is currently selling for $49.31 per share. The firm paid a $4.06 dividend last year and expects dividends to continue growing at a rate of 4.4% per year. The firm's marginal tax rate is 34%. What discount rate should you use to evaluate the warehouse projects?
Solve the following:
a. Calculate component weights of capital
1. The weight of debt in the firm's capital structure is ____%?
2. The weight of preferred stock in the firm's capital structure is____%
3. The weight of common stock in the firm's capital structure is ___%
b. Calculate component costs of capital.
1. The after-tax cost of debt for the firm is ___%
2. The cost of preferred stock for the firm is __%
3. The cost of common equity for the firm is ___%
c. Calculate the firm's weighted average cost of capital.
1. The discount rate you should use to evaluate the warehouse project is ___%
Source of Capital Market Value Bonds $540,000 Preffered Stock $110,000 Common Stock $420,000Explanation / Answer
Calculation of weights of the component
Total value of the firm capital structure = Value of bonds + Value of preferred stock + Value of common stock
= 540000+110000+420000
=1070000
Weight of bond = Value of bond / Total value of firm
= 540000/1070000 i.e 50.47%
Weight of preferred stock = Value of preferred stock / Total value of firm
= 110000/1070000 i.e 0.10.28%
Weight of common stock = Value of common stock / Total value of firm
= 420000/1070000 i.e 39.25%
Calculation of cost of capital
After tax cost of debt = 7.8(1-Tax)
= 7.8( 1-0.34) i.e 5.148
After tax cost of preferred stock = Preference dividend ( 1-Tax)
= 7.50(1-0.34) i.e 4.95
Price of common stock = D1/Ke-G
49.31 = 4.06(1+0.044)/Ke-0.044
49.31 = 4.24/Ke-0.044
49.31Ke - 2.16964 = 4.24
Ke = 6.41/49.31 i.e 13%
WACC =( Weight of debt * Cost of debt)+ (Weight of [preferred stock * Cost of preferred stock) + ( Weight of common stock * Cost of common stock)
= (0.5047*5.148)+(0.1028*4.95)+(0.3925*13)
= (2.60+0.509+5.10)
= 8.209%
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.