7.2 Masco Oil Gas Co. (cost of capital financing needs changing) Masco Oil and G
ID: 2753419 • Letter: 7
Question
7.2
Masco Oil Gas Co. (cost of capital financing needs changing)
Masco Oil and Gas Company is a big company whose common shares are listed on the stock exchange in New York and bonds traded on the market for over the counter sales. According to the current balance sheet, there are three outstanding issues:
$ 150 million series 2015 ------------- 10%
$ 50 million 7% ---------------------- 2009 series
$ 75 million series 5% ---------------------- 2006
CFO is planning to sell $ 75 million of bonds in the next year to replace the debt that is due to expire in 2006. The current market yield on similar bonds are rated as Baa 12.1%. Masco also has $ 90 million of preferred shares are not redeemable 7.5% in circulation, and does not intend to sell any preferred stock at any time in the future. The preferred stock is currently valued at $ 80 a share and dividend per share is $ 7.80.
The company has been very volatile profits, but its earnings per share have had a very stable growth rate of 8% and this will continue in the future. The expected dividend (D1) is $ 1.90 per share, and the common shares sold at $ 40 per share. The investment banker quoted the company has the following costs will float to Masco: $ 2.50 per share for the preferred stock and $ 2.20 per share for the common stock.
With the advice of its investment banker, Masco has maintained its debt to 50% of assets and 50% equity. Masco sees no need to sell either common or preferred shares in the foreseeable future as it has generated enough internal to their investment needs funds when these funds are combined with financing through debt. The corporate tax rate is 40% Masco
Calculate capital cost for the following
A) Bonds (debt) (Kd)
B) Preferred Capital (Km)
C) common equity in the form of retained earnings (Ke)
D) weighted average cost capital.
*** 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
Answer-A
Cost of bonds:
Current market yield for the similar bond = 12.1%
Therefore Kd = 12.1%
Answer-B
Preferred capital = $90 million
Preferred dividend = 7.5%
Current price of preferred stock = $80
Dividend per share = $7.8
Floatation cost = $2.5
Net proceeds after floatation cost = $80 - $2.5 = $77.5
Therefore yield on preferred stock = $7.8/$77.5= 0.01006 or 10.06%
Km = 10.06%
Answer-C
Cost of common equity:
Growth rate = 8%
Expected dividend = D1 = $1.9 per share
Current market price of share = $40 per share
Floatation cost = $2.2 per share
So market price of share after adjusting floatation cost = $40-$2.2 = $37.8
Ke = D1/MP + g% = $1.9/$37.8 + 8% = 0.0502 + 0.08 = 0.1303 or 13.03%
Answer-D
Corporate tax rate = 40%
Total equity = $150 + $50 + $75 = $275 million
Total Debt = $75 million
Total preference share = $90
Total capital = $275 + $75 + $90 = $440 million
Therefore weights can be calculated:
Weight of debt = Wd = $75/$440 = 0.1705
Weight of equity = We = $275/$440 = 0.625
Weight of preference share = Wm = 0.2045
WACC = 0.1705 x 12.1% x (1-40%) + 0.2045 x 10.06% + 0.625 x 13.03%
WACC = 1.2378% + 2.057% + 8.144% = 11.43855 or 11.44%
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