StudentShare solutions

# Finance 6 - Essay Example

## Extract of sampleFinance 6

Thus from the given data, Kd = (8.5%) (1-0.30) = 5.95%

b. The cost of preferred stock is calculated by the following formula:
Kp = Dp / [Pp (1-F)]
Where, Kp = cost of preferred stock
Dp = preferred dividend
Pp= preferred stock price
F= floatation cost (Brigham & Daves, 2009, p.330).
From the data, Kp = 9/91 = 9.89%

c. Cost of common stock (at constant growing rate) can be calculated by the following formula: Ks = (D1/P0) + g
Where, Ks = cost of common stock
D1 = Dividend at the end of the first year
P0 = price of the stock at the beginning of the first year
g = growth rate (Gitman, 2007, p.448).
From the data, Ks = (0.75/15) + 0.06 = 11%
d. Calculation of Weighted Average Cost of Capital (WACC):
Capital Component Percentage of capital structure Cost Product (Percentage×Cost)
Debt 0.35 5.95% 2.08%
Preferred Stock 0.05 9.89% 0.49%
Common Stock 0.60 11% 6.60%
WACC 9.17%

Page 1 No. 2 Solution:
Cost of retained earnings (Kre) = Ke (1-f)
Where, Kre = cost of retained earnings
Ke = cost of equity
f = floatation cost (Kapil, 2011, p.278).
Ke = (2.10/34) + 0.06 = 12%
From the given data, Kre = 0.12 (1-2.38) = (16.56%) (negative)

Cost of new common stock (Kn) = (D1/Nn) + g
Where, Kn = cost of new issues of common stock
D1 = Dividend at the end of first year
Nn = net proceeds from the sale of new common stocks
g = constant growth rate (Gitman, 2007, p.448)
From the given data, Kn = (2.10/34) + 0.06 = 12.18%
...
The original balance sheet reflects 10 percent debt and 90 percent equity. It may here be observed that companies in general tend to lessen their amounts of debts and increase equity amounts or make investments. In the long run in the business operations of any company, the concept of remaining free of debt may not pay well for the business profits. Instead it may be preferable to base a company’s capital structure on the cost of capital for the company. Thus, borrowing money for a long term and reinvesting the amounts in business projects is expected to generate profits for the company. Hence, an optimal structure may reflect on 30-40 percent of debt and the rest in equity for the firm (Kennon, 2011). c. A company may alter its capital structure and buy certain amounts of equity in exchange for new debt thus substituting debt for equity. This would not have any effect on the cost of capital of the company since the overall cost of capital employed does not change. The transaction remains neutral both for the company as well as the investor (Vernimmen & Quiry, 2009, p.448). d. If a company uses too much of debt financing, then the financial condition of the company may be in a difficult situation. This is primarily because in the long run, the company may lose its value and that tends to increase the cost of capital of the firm. An optimal capital structure of a firm largely depends on the business risk of the firm; greater the risk higher is the possibility for the company to obtain its optimal capital structure (Drake & Fabozzi, 2010, p.178). Page 3 No.1 Solution: Assuming the cost of capital to be 10% and 12% the NPVs can be calculated on the costs and cash flows as given in the data. At 10%, NPV = \$ 1102.98 At ...Show more

## Summary

Topic: Finance 6
Page 1 No.1 Solution:
a. The after-tax cost of capital can be calculated by the following formula:
Kd = (I/P) (1-T)
Where, Kd = after-tax cost of debt
I = interest in dollars
P = principal amount borrowed
Author : seanvon
Save Your Time for More Important Things
Let us write or edit the essay on your topic
"Finance 6"
with a personal 20% discount.
Grab the best paper

### Related Essays

Finance
This process of international expansion is made possible by the business corporations depending on certain premises like conducting trades related to exporting of commodities to foreign nations, through rendering investment in business units created in foreign territories, opening up of new production units in the foreign locations
4 pages (1000 words) Essay
Finance
Then, explanations and justifications of the results are discussed with some suggestions for improvements. Product Division Category Ratio 2009 2008 Result Liquidity Ratios Current Ratio 1.33 1.09 Unfavorable Quick Ratio 0.63 0.47 Unfavorable Stock Turnover 113.84 99.51 Favorable Debtor Days 42.69 27.58 Unfavorable Creditors Days 29.15 51.06 Unfavorable Profitability Ratios Net Profit Margin 3.36% 1.98% Favorable Operating Profit Margin 6.38% 5.71% Favorable Return on Assets 3.56% 1.96% Favorable Return on Equity 10.23% - Critical Analysis:- Liquidity which is defined by Lawrence J.
4 pages (1000 words) Essay
Finance
The investors take diversified investment strategy, where they invest their money in national as well as international investment instruments. Here the researcher tends to analyse the key mechanism of international investment diversification. The diversification process in their investments consist of different types of activities viz.
6 pages (1500 words) Essay
CORPORATE FINANCE - MODULE 6 MINICASE
In the process, managers firstly estimate the cash flows, then they assess the risk associated with the cash flows, then they determine the cost of capital. Finally, managers evaluate the cash flows, and then decide which projects to include in the capital budget.
11 pages (2750 words) Essay
MBA - Corporate Finance - Capital Budgeting - 6 question
b. With no capital rationing, the primary consideration in selecting a project is the NPV. Theoretically, all projects which yield positive NPVs should be selected should there be no budget constraint.
6 pages (1500 words) Essay
Finance 6
In the long run in the business operations of any company, the concept of remaining free of debt may not pay well for the business profits. Instead it may be preferable to base a company’s
5 pages (1250 words) Essay
Solving 6 Qs of Finance class
Place a value on a prize won by Mary Richard. She thought that she won \$5 million until the lottery company advised her that it was not paid in one sum up-front. What is the value of Mary’s \$5 million if it is to be paid to her in equal
4 pages (1000 words) Essay
Finance Week 6
A lot of people think that debt is bad due to their personal bias in dealing with debt in their own lives. In the business world debt is a critical component of the capital financing of an organization. The use of leverage can help an
1 pages (250 words) Essay
Development Finance & Funding Report: Discuss the main drivers for commercial property development in the central London area over the last 6 years. Have BIDS been a significant factor for good in this area Discuss the above 2 items in relation to
In fact, the town is currently the leading financial centers in the world alongside New York City in the U.S. At the same time, the city has been described by many as a cultural
11 pages (2750 words) Essay
Finance
It is calculated as difference close price on the date of listing and offer price of issue expressed as percentage of offer price of issue. In the US market, the short
10 pages (2500 words) Essay
Get a custom paper written
by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger