7.1 *** NOTE: No copying answers from other questions in this system are incorre

Question

7.1

*** NOTE: No copying answers from other questions in this system are incorrect. IT IS VERY IMPORTANT TO COMPLETE THE ENTIRE EXERCISE. INCLUDE ALL CALCULATIONS. THANK

In this task you use the CAPM model to calculate the required return on investment.

Problem 1:

Royal Road Company, Inc. wants to increase its debt by selling bonds to $ 900 par value with a coupon interest of 13% to 10 years, which will be paying annual interest. To do sale, a $ 30 bonus will be offered. Costs incurred in this issue (flotation costs) are $ 15 per bond. Use the approximation formula to calculate the cost of debt.

Problem 2:

The company Maximum All-Stars, Inc. like to discuss the offer of preferred shares West Coast International company. The company plans to issue 15% of preferred shares to sell the par value of $ 63 per share. Costs incurred in this issue (flotation costs) are $ 7 Action. Calculate the cost of these preferred shares.

Problem 3:

Pure Diamond Company, Inc. has consistently paid dividends for 30 years. Dividends have grown at a compound annual rate of 7%. The share price is currently $ 75 and the company plans to pay dividends of $ 5.50 for the next year. Costs incurred in this issue (Flotation costs) are $ 6 per share. Calculate the cost of capital of the common shares.

Problem 4:

Tropical Aloha, Inc. has in its capital structure the following composition: 40% debt and 60% equity. The estimated cost of debt after tax is 7% and the estimated cost of capital is a 15%. Calculate the weighted average cost of capital (WACC).

*** NOTE: No copying answers from other questions in this system are incorrect. IT IS VERY IMPORTANT TO COMPLETE THE ENTIRE EXERCISE. INCLUDE ALL CALCULATIONS. THANK

Explanation / Answer

Part A)

The cost of debt using approximation formula can be calculated as follows:

Cost of Debt = (Interest Payment + (Par Value - Price)/Maturity)/(Par Value - Price)/2

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Here, Interest Payment = 1,000*13% = $130, Par Value = $900 and Price = 900 + 30 - 15 = $915

Using these values in the above formula, we get,

Cost of Debt = [130 + (900 - 915)/10]/(900 + 915)/2 = 14.16%

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Part B)

The cost of preferred shares can be calculated with the use of following formula:

Cost of Preferred Shares = Annual Dividend/Market Price*100

Where, Market Price = Par Value - Flotation Cost

__________

Here, Annual Dividend = 63*15% = $9.45 and Market Price = 63 - 7 = $56

Using these values in the above formula, we get,

Cost of Preferred Shares = 9.45/56*100 = $16.875 or $16.88

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Part C)

The cost of capital can be calculated with the use of following formula:

Cost of Capital = Expected Dividend/(Current Share Price - Flotation Cost) + Growth Rate

__________

Using the values provided in the question, we get,

Cost of Capital = 5.50/(75 - 6) + 7% = 14.97%

____________

Part D)

The WACC can be calculated with the use of following formula:

WACC = Weight of Equity*Cost of Equity + Weight of Debt*After-Tax Cost of Debt

__________

Using the values provided in the question, we get,

WACC = 60%*15% + 40%*7% = 11.80%

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