(Weighted average cost of capital) As a member of the Finance Department of Ranc
ID: 2808226 • Letter: #
Question
(Weighted average cost of capital) As a member of the Finance Department of Ranch Manufacturing, your boss has asked you to compute the appropriate discount rate to use when evaluating the purchase of new packaging equipment for the plant. Under the assumption that the firm's present capital structure reflects the appropriate mix of capital sources for the firm, you have determined the market value of the firm's capital structure as follows: Source of capital Bonds Preference shares Ordinary shares Market values $4000000 $2000000 $6000000 To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying interest at a rate of 7% per year (with semi-annual payments) at the market price of $1050. Preference shares paying a $2.00 dividend can be sold for $25. Ordinary shares for Ranch Manufacturing are currently selling for $55 each and the firm paid a $:3 dividend last year. Dividends are expected to continue growing at a rate of 5% per year into the indefinite future. If the firm's tax rate is 30%, what discount rate should you usc to evaluatc the cquipment purchasc?Explanation / Answer
Market Value %of capital Cost of capital % of Capital x Cost of Capital Bond $4,000,000.00 33.33% 4.42% 1.47% Preferred stock $2,000,000.00 16.67% 8.00% 1.33% Common stock $6,000,000.00 50.00% 10.73% 5.36% Total 1200000000.00% 100.00% WACC 8.17% WACC = Discount Rate = 8.17% Cost of Debt NPER = 10 x 2 20 Coupon Rate = 7%/2 3.50% Coupon Payment PMT 35 PV 1050 FV 1000 Semiannual YTM = RATE(20,35,-1050,1000) 3.16% Annual YTM = 3.16% x 2 6.32% After tax rate = 6.32% x (1 - 30%) 4.42% Cost of Equity Dividend $3.00 Price $55.00 Growth 5.00% Cost of Equity = {D0 x (1 + g)/PO} + g = ($3 x 1.05/$55) + 5% 10.73% Cost of Preferred stock Dividend $2.00 Price $25.00 Cost of Preferred stock = $2/$25 8.00%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.