(Weighted average coil of capital) Crawford Enterprises is a publicly held compa
ID: 2726269 • Letter: #
Question
(Weighted average coil of capital) Crawford Enterprises is a publicly held company located in Arnold,. The firm began as a small tool and die shop but grew over its 35-year life to become a leading supplier of metal fabrication equipment used in the farm tractor industry. At the close of 2009 the firm's balance sheet appeared as follows: At present the firm's common stock is selling for a price equal to its book value, and the firm's bonds are seiling at par. Crwford's managers estimate that the market requires a return of 18 percent on its common stock, the firm's bonds command a yield to maturity of 7 percent, and the firm faces a tax rate of 33 percent. What is Crawford's weighted average cost of capital? If Crawford's a stock price were to rise such that it sold at 1.5 times book value, causing the cost of equity to fall to 16 percent, what would the firm's cost of capital be (assuming the cost of debt and tax rate do not change)?Explanation / Answer
Part A
After-tax cost of debt = yield x (1- t)
= 0.07 x (1-0.33)
= 4.69%
Source
Amount
Cost
Cost x amount
Debt
10520000
5%
493388
Equity
20684000
18.00%
3723120
Total
31204000
4216508
Weighted average cost of capital = sum of cost x amount / sum of amount
= 4216508/ 31204000
= 13.51%
Part B
Market value of equity = book value of equity x market value to book value ratio
= 20684000 x 1.50
= 31026000
Source
Amount
Cost
Cost x amount
Debt
10520000
5%
493388
Equity
31026000
16.00%
4964160
Total
41546000
5457548
Weighted average cost of capital = sum of cost x amount / sum of amount
= 5457548/ 41546000
= 13.14%
Source
Amount
Cost
Cost x amount
Debt
10520000
5%
493388
Equity
20684000
18.00%
3723120
Total
31204000
4216508
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