The Weighted Average Cost Of Capitalby The Due Date Assi
Assignment 2: The Weighted Average Cost of CapitalBy the due date assigned , complete the following assignment:Coogly Company is attempting to identify its weighted average cost of capital for the coming year and has hired you to answer some questions they have about the process. They have asked you to present this information in a PowerPoint presentation to the company’s management team. The company would like for you to keep your presentation to approximately 10 slides and use the notes section in PowerPoint to clarify your point. Your presentation should address the following questions and offer a final recommendation to Coogly. Make sure you support your answers and clearly explain the advantages and disadvantages of utilizing the weighted average cost of capital methodology.
Include at least one graph or chart in your presentation.
Company Information The capital structure for the firm will be maintained and is now 10% preferred stock, 30% debt, and 60% new common stock. No retained earnings are available. The marginal tax rate for the firm is 40%.Coogly has outstanding preferred stock That pays a dividend of $4 per share and sells for $82 per share, with a floatation cost of $6 per share. What is the component cost for Coogly's preferred stock?
What are the advantages and disadvantages of using preferred stock in the capital structure?
If the company issues new common stock, it will sell for $50 per share with a floatation cost of $9 per share. The last dividend paid was $3.80 and this dividend is expected to grow at a rate of 7% for the foreseeable future. What is the cost of new equity to the firm? What are the advantages and disadvantages of issuing new equity in the capital structure?
The company will use new bonds for any capital project, according to the capital structure. These bonds will have a market and par value of $1000, with a coupon rate of 6% and a floatation cost of 7%. The bonds will mature in 20 years and no other debt will be used for any new investments. What is the cost of new debt? What are the advantages and disadvantages of issuing new debt in the capital structure?
Given the component costs identified above and the capital structure for the firm, what is the weighted average cost of capital for Coogly? What are the advantages and disadvantages of using this method in the capital budgeting process?
Paper For Above instruction
The assessment of a company's Weighted Average Cost of Capital (WACC) is a fundamental aspect of corporate finance, providing insights into the minimum return required to satisfy all capital providers. For Coogly Company, understanding the components of its WACC, including the cost of preferred stock, equity, and debt, involves analyzing each element's specific costs, the company's capital structure, and the associated advantages and disadvantages of each source of financing.
**Cost of Preferred Stock**:
The preferred stock pays a dividend of $4 per share, sells for $82, with flotation costs of $6 per share. The component cost of preferred stock (k_ps) is calculated using the formula:
k_ps = (D_ps / P_net) = Dividend / (Price - Flotation Cost)
Substituting the given values:
k_ps = $4 / ($82 - $6) = $4 / $76 ≈ 0.0526 or 5.26%
This cost reflects the return required by preferred shareholders, considering issuance costs.
**Advantages of Preferred Stock**:
- It provides a fixed dividend, offering predictability.
- It does not dilute common equity.
- Preference over common stock in dividends and liquidation.
**Disadvantages of Preferred Stock**:
- Dividend payments are obligatory, impacting cash flow.
- It is considered a hybrid security, with higher cost than debt.
- Issuance involves flotation costs, increasing initial expense.
Cost of New Equity
The company plans to issue new common stock at $50 per share, with flotation costs of $9, last dividend of $3.80, and dividend growth rate of 7%. The cost of new equity (k_e) is calculated using the Dividend Discount Model (DDM):
k_e = (D1 / P_net) + g
Where:
D1 = last dividend grown by the growth rate:
D1 = $3.80 * (1 + 0.07) = $4.066
P_net = Price - Flotation cost = $50 - $9 = $41
Therefore:
k_e = $4.066 / $41 + 0.07 ≈ 0.0994 + 0.07 = 0.1694 or 16.94%
**Advantages of Issuing New Equity**:
- No obligation of fixed payments.
- Equity can be used to finance growth without increasing leverage.
- Enhances financial flexibility.
**Disadvantages of Issuing New Equity**:
- Dilutes existing ownership.
- Can send negative signals to the market.
- Higher flotation costs compared to retained earnings or debt.
Cost of New Debt
The firm will issue bonds with a face value of $1000, coupon rate 6%, flotation costs 7%, and maturity of 20 years. The cost of debt (after-tax) (k_d) is calculated as follows:
Before-tax cost of debt (YTM) ≈ Coupon rate, adjusted for flotation costs:
Net proceeds = Par value - Flotation cost = $1000 - (0.07 * $1000) = $930
Approximate yield:
k_d = (Coupon / Net proceeds) = ($60 / $930) ≈ 0.0645 or 6.45%
Adjusted for taxes:
After-tax cost of debt = k_d * (1 - tax rate) = 6.45% * (1 - 0.40) = 3.87%
**Advantages of Issuing New Debt**:
- Tax-deductible interest payments reduce overall cost.
- Maintain control without diluting ownership.
- Typically lower cost compared to equity.
**Disadvantages of New Debt**:
- Increased financial leverage increases bankruptcy risk.
- Debt covenants may restrict operational flexibility.
- Fixed interest obligations regardless of company performance.
Weighted Average Cost of Capital (WACC)
Using the component costs and the company's target capital structure (10% preferred stock, 30% debt, 60% equity), the WACC is calculated as:
WACC = (E/V) * k_e + (D/V) * k_d * (1 - tax rate) + (P/V) * k_ps
Where V = total capital, E = equity, D = debt, P = preferred stock weightings.
Applying the values: WACC = 0.60 * 16.94% + 0.30 * 3.87% + 0.10 * 5.26% ≈
**Advantages of Using WACC**:
- Reflects the average return required by all capital providers.
- Used as a discount rate in capital budgeting.
- Encourages balanced capital structure optimization.
**Disadvantages of Using WACC**:
- Assumes constant weights and costs, which may vary over time.
- Sensitive to estimation errors of component costs.
- May not account for project-specific risks.
Conclusion
Coogly’s WACC of approximately 11.85% provides a comprehensive measure to evaluate potential investments and strategic decisions. While employing WACC offers significant advantages in standardizing investment evaluation and aligning with company capital structure, it also possesses limitations related to its static assumptions and estimation accuracy. Careful periodic recalibration and considering project-specific risk adjustments can enhance decision-making quality based on WACC.
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