Jack was recently hired by Coleman Electronics as a junior budget analyst. He is
ID: 2649180 • Letter: J
Question
Jack was recently hired by Coleman Electronics as a junior budget analyst. He is working for the Venture Capital Division and has been given for capital budgeting projects to evaluate. He must give his analysis and recommendation to the capital budgeting committee/
Jack has a B.S. in accounting from WWU (2007) and passed the CPA exam (2008). He has been in public accounting for 2 years. During that time he earned an MBA from Seattle U. He would like to be the CFO of a company someday--maybe Coleman Electronics-- and this is an opportunity to get onto that career track and to prove his ability.
As Jack looks over the financial data collected, he is trying to make sense of it all. He already has the most difficult part of the analysis complete -- the estimation of cash flows. Through some internet research and application of finance theory, he has also determined the firm
Explanation / Answer
1) Cost of debt = Interest rate(1 -tax)
= 10 (1 -.35)
= 6.5%
2)Cost of preferred stock = Dividend*100 / Issue proceeds
= 10*100/105
= 9.52%
3) (1)Cost of equity CAPM = Risk free rate + Beta(Return on market-risk free rate)
= 2.5 + 1.2(12-2.5)
=13.90%
(2)Cost of equity using DCF =Current price = [Dividend(1 +growth)]/(Cost of equity -growth)
36= [3(1+.06)]/(Cost of equity -.06
36 = 3.18/cost of equity -.06
cost of equity -.06 = 3.18/36
cost of equity = 14.83%
3)Bond yield premium approach = Bond yield + Risk premium
10 % + 3%
13 %
4)since minimum cost of equity that shareholder is expecting is as per Bond yield plus risk premium approach therefore we will take cost of equity = 13 %
4) WACC=
WACC 9.402% (3.25+.952+5.2)
Weights Cost of equity weighted average Debt .50 6.50 3.25 Preferred stock .10 9.52 .952 equity .40 13 5.2Related Questions
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