A company has the following capital structure: Accounts payable over 30 days old

Question

A company has the following capital structure:

Accounts payable over 30 days old incur a cost of 1.5% per month. About half the accounts are older than 30 days. Common stock has a market price of $15 and earnings per share of $3.50 after taxes, of which $1.50 is paid as dividends.

(a) Obtain a weighted average cost of capital, assuming a marginal tax rate of 40%

(b) is your numerical answer in part (a) a good value to use for MARR? Explain.

Loans, 9% $100,000 Loans, 12% 100,000 Accounts Payable 200,000 Mortgage, 8% 400,000 total liabilities sum of 1st 4 (800,000) Common Stock 100,000 Total liability and equity sum of total liabilites and common stock (900,000)

Explanation / Answer

a) Cost of loans can be computed as weighted average of 9%, 12%, 18% and 8% respectively.

Note: 18% for account payable as it has 1.5% per month cost.

Hence, Cost of Debt, Kd = (0.09*100000+0.12*100000+0.18*200000+0.08*400000)/800000 = 11.125%

EPS = $3.5 (inc. Dividends) and Share Price = $15 => Cost of equity, Ke = 3.5/15 = 23.33%

Now, WACC = E/(D+E)*Ke + D/(D+E)*[1-T)*Kd where D = 800000 and E = 100000 and T = 40% i.e. tax rate.

=> WACC = (1/9)*0.11125 + (8/9)*(1-0.4)*0.2333 = 13.67% [Answer]

b) No, the numerical value calculated for MARR in part 1 is not perfect as accounts payable is for short duration and its cost of capital is assumed as very high as 18% as if it also a long term debt.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.