c. Internal common equity where the current market price of the common stock is $43.50. The expected dividend this coming year should be $3.25, increasing thereafter at a 7% annual growth rate. The corporation’s tax rate is 34%. d. A preferred stock paying a 10% dividend on a $125 par value. If a new issue is offered, flotation costs will be 12% of the current price of $150.
Dixita Patel Chapter 6 homework Managerial Finance July 31, 2012 Critical Thinking 6.6. Coupon rate: how does bond issuer decide on the appropriate coupon rate to set on its bonds? Explain the difference between the coupon rate and the required return on a bond price? Coupon rate is the annual coupon divided by the face value of a bond. In this case Bond Issuers look at outstanding bonds of comparable maturity and risk.
The WACC would only be the cost of equity. Cost of Equity – We calculate the cost of equity using as an average of the cost based on CAPM, DCH and bond yield plus risk premium approach 1. CAPM – Under CAPM, cost of equity is calculated as Cost of equity = Rf + (Rm-Rf) beta where Rf = risk free rate which is taken as the long term rate to match the maturity of the project. Since the project is 8 years, we take the 10 year Treasury bond rate as the risk free rate. The current 10 year Treasury bond rate is 2.32% (Rm -Rf) is the market risk premium and is assumed to be 5.5% Beta
A1 of 3 Formulas involved on the WACC calculations Corporate Finance - MBA 2009 Note written by Prof. Carles Vergara-Alert & Prof. Pedro Saffi 1 Objective This note tries to clarify the different assumptions and formulas used to calculate the Weighted Average Cost Of Capital (WACC) that you will find in different textbooks and articles. 2 The WACC formula The WACC formula is a weigthed average of the cost of equity and the after-tax cost of debt: W ACC = E D+E RE + D D+E (1 − τ )RD (1) being RE the cost of equity, RD the cost of debt, τ the corporate tax, E the market value of the firm’s equity, and D the market value of the firm’s debt. Note that sometimes we call V to the sum of D and E, therefore, V = D + E. Sometimes, not all the financing is provided by debt and equity. As an example, let us assume that some financing is provided by preferred stock as well as equity and debt. The WACC formula has to be modified to include the main sources of long-term financing of the firm such as preferred stock: W ACC = E D P RE + (1 − τ )RD + RP D+E+P D+E+P D+E+P where RP is the cost of preferred stock and P is the market value of the firm’s preferred stock.
Valuation Case Tottenham Hotspur, Plc. 1a – the value of Tottenham Hotspur based on the projections given in the case using a DCF analysis Weighted Average Cost of Capital (WACC) In this paragraph we discuss the WACC of Tottenham Hotspur. In the process of calculating WACC and determining the value of the company we assume that we are valuing the company from the perspective of the marginal investor. Value of debt We use the book value of all interest bearing debt at 31-12-2007 to estimate the value of debt, this equals 43,08 million. We miss essential information like the interest rate and maturity of the debt to calculate the market value of debt.
The Weighted Average Cost of Capital (WACC) is an average representing the expected return on all of a company's securities. Each source of capital, such as stocks, bonds, and other debt, is assigned a required rate of return, and then these required rates of return are weighted in proportion to the share each source of capital contributes to the company's capital structure. The resulting rate is what the firm would use as a minimum for evaluating a capital project or investment. After studying Joanna Cohen’s analysis for Nike, Inc, we found some flaws and we believe that some of the assumptions that she made were incorrect and somewhat altered the outcome of the WACC calculation. i) Joanna used the total shareholders’ equity figure in 2001 from the balance sheet of Exhibit 3.
Marriott uses three inputs to determine the opportunity cost of capital: debt capacity, debt cost and equity cost consistent with the amount of debt. Calculating the WACC will be determined using the following four steps: 1) Calculate target levered beta, 2) Determine cost of debt, 3) Determine cost of equity and 4) Calculate WACC. The first step is to calculate the targeted levered beta, which is found by using the equity beta of Marriott from Exhibit 3 in the case. The tax rate was assumed to be 34% from our class discussion and the targeted debt-to-equity of 1.11 from Table A in the case. See “Appendix A” for calculations of targeted levered beta.
Finance division evaluates investments using “Weighted Average Cost of Capital” (Wacc) as a hurdle rate to discount the cash flows for an investment opportunity. This Wacc is calculated from two subgroups; cost of equity and cost of debt, giving appropriate weightage to each group. 2. Problem Statement: Following points need to be analyzed; - What risk-free rate and risk premium should be used for cost of equity? - How does the cost of debt for Marriott should be calculated.
It appears not to be the case. Some could argue that the interest rates are not sensitive to the demand for money. Would an upward sloping LM curve still be applicable?. Explain your reasoning. The LM curve would not be applicable seeing as though the decision to reduce the federal funds is a monetary policy affect the IS curve solely.
Date: 24th September 2013 Marriott Case FINE 443 Q1. Cost of Capital for Marriott: Cost of Equity – E(RE) : To calculate the cost of equity we will use the CAPM formula with the unlevered beta of Marriot. Since Marriot is a long-term investment we assume that the risk free rate is 4.58% taken from Exhibit 4 and that the market risk premium is 7.43% from Exhibit 5. Rf=4.58% (long-term government bonds) βE=βU+βU(1-t)(DE) 0.97=βU+βU(1-0.34)(0.410.59) βu=0.665 Market Risk Premium: 7.43% (Spread between S&P 500 composite and L-T government bond) E(Re)=Rf+βuMarket Risk Premium E(Re)=0.0458+0.6650.0743 E(Re)=9.521% Cost of Debt -RD : To calculate the cost of debt we use the government interest rates (Table B) and add the debt rate premium to it (Table A). For Marriot we the interest rates for a maturity of 10 years rather 30 years because Marriot is made up of both divisions which are long-term and short-term in nature and therefore decided on an average of 10 years to account for their nature RD= Gov L-T rate+ Debt rate premium = 0.0872+0.0130 = 10.02% Weighted average cost of capital: WACC=1-trDDV+ reEV D/V= 60% E/V=40% t=34% WACC=1-0.340.10020.60+ 0.095210.4 WACC=7.78% The weighted average cost of capital for Marriott is 7.78% Q2.