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Chapter 4: Q11-19BP (page 366)

Global Technology鈥檚 capital structure is as follows:

Debt ............................................ 35%

Preferred stock ........................... 15

Common equity .......................... 50

The aftertax cost of debt is 6.5 percent; the cost of preferred stock is 10 percent; and the cost of common equity (in the form of retained earnings) is 13.5 percent. Calculate Global Technology鈥檚 weighted average cost of capital in a manner similar to Table11-1

Short Answer

Expert verified

The weighted average cost of capital is10.53%.

Step by step solution

01

Meaning of Cost of Capital 

Cost of capital is used in finance management and refers to the minimum return a business entity needs to create to cover the costs incurred in the capital project.

02

Step 2:Calculation of weighted average cost of capital

Particular

Cost after tax

Weights

Weighted Cost

Debt

6.5%

35%

2.28%

Common stock

10%

15%

1.5%

Preferred stock

13.5%

50%

6.75%

Weighted average cost of capital

10.53%

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Most popular questions from this chapter

How much would you have to invest today to receive a. $15,000 in 8 years at 10 percent?

Myers Business Systems is evaluating the introduction of a new product. The possible levels of unit sales and the probabilities of their occurrence are given next:

Possible Market Reaction Sales in Units Probabilities

Low response ....................................... 20 0.10

Moderate response .............................. 40 0.30

High response ...................................... 55 0.40

Very high response ............................... 70 0.20

a. What is the expected value of unit sales for the new product?

b. What is the standard deviation of unit sales?

Keller Construction is considering two new investments. Project E calls for the purchase of earthmoving equipment. Project H represents an investment in a hydraulic lift. Keller wishes to use a net present value profile in comparing the projects. The investment and cash flow patterns are as follows:

Project E (\(20,000 Investment)

Year

Cash flows

1

\)5,000

2

6,000

3

7,000

4

10,000

Project H (\(20,000 Investment)

Year

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\)16,000

2

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3

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  1. Determine the net present value of the projects based on a zero percent discount rate.

  2. Determine the net present value of the projects based on a 9 percent discount rate.

  3. The internal rate of return on Project E is 13.25 percent, and the internal rate of return on Project H is 16.30 percent. Graph a net present value profile for the two investments similar to Figure12-3. (Use a scale up to \(8,000 on the vertical axis, with \)2,000 increments. Use a scale up to 20 percent on the horizontal axis, with 5 percent increments.)

  4. If the two projects are not mutually exclusive, what would your acceptance or rejection decision be if the cost of capital (discount rate) is 8 percent? (Use the net present value profile for your decision; no actual numbers are necessary.)

  5. If the two projects are mutually exclusive (the selection of one precludes the selection of the other), what would be your decision if the cost of capital is (1) 6 percent, (2) 13 percent, (3) 18 percent? Once again, use the net present value profile for your answer.

Jim Busby calls his broker to inquire about purchasing a bond of Disk Storage Systems. His broker quotes a price of \(1,180. Jim is concerned that the bond might be overpriced based on the facts involved. The \)1,000 par value bond pays 14 percent interest, and it has 25 years remaining until maturity. The current yield to maturity on similar bonds is 12 percent. Compute the new price of the bond and comment on whether you think it is overpriced in the marketplace.

The Woodruff Corporation purchased a piece of equipment three years ago for \(230,000. It has an asset depreciation range (ADR) midpoint of eight years. The old equipment can be sold for \)90,000.

A new piece of equipment can be purchased for \(320,000. It also has an ADR of eight years.

Assume the old and new equipment would provide the following operating gains (or losses) over the next six years:

Year New Equipment Old Equipment

1 .................... \)80,000 $25,000

2 .................... 76,000 16,000

3 .................... 70,000 9,000

4 .................... 60,000 8,000

5 .................... 50,000 6,000

6 .................... 45,000 (7,000)

The firm has a 36 percent tax rate and a 9 percent cost of capital. Should the new equipment be purchased to replace the old equipment?
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