Topical review
- Explain the uses of WACC, such as capital budgeting and corporate valuation
- Explain how to determine the cost of individual components of capital
- Should be marginal, after-tax costs
- Cost of debt - YTM after-tax
- Cost of preferred stock
- Cost of equity
- Three methods (CAPM, DDM, bond-yield-plus-risk-premium)
- CAPM and DDM issues – difficulty in estimating the inputs
- Discuss the general effects of floatation costs on costs of capital
- Compute the WACC
- Given a specific (target) capital structure
- Always use market value weights - especially for equity
- Adjust WACC for risk - CAPM or subjective adjustment
- Suggest some ways that firms may lower their WACC
- Cost of capital - WACC, marginal cost of capital, (after-tax) cost of debt, cost of equity
- Flotation costs, target capital structure
ST-1, 4-6, 16
2 comments:
could you explain how they book got the answers for problem 9-16?
The point of this question is that weights for WACC should be based on MARKET value. So you have to convert what you know on the balance sheet (book value) to market value.
First, value the bonds.
FV=1000 (per bond),
N=20 (it says annual coupon)
PMT=60
I=10
so PV=659.46 (per bond)
There are 30,000 bonds so total market value of the debt is 19,783,724.
There is 1 million shares of stock selling for $60 per share so market value of equity is $60 million.
Since the company uses short-term debt as permanent capital, we also include short-term debt. Since they are short-term and constantly rolling over, we assume that the market value is really close to book value of $10 million.
Total capital = s-t debt + bonds + equity = 89,783,724. And the weight in debt is 19,783,724/89,783,724 = 22.03%
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