A- plus writer 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 pres
WELCOME TO THE PRESENTATION
CALCULATION OF COOGLY’S COST OF PREFERRED STOCK
As flotation cost increases cost. So, issue price will be reduced by the amount of flotation cost to reflect the increased cost in the cost of preferred stock
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ADVANTAGE AND DISADVANTAGE OF PREFERRED STOCK
- Advantage:
- It is risk less leverage advantage. Holders cannot force for insolvency if dividend is not paid
- There is no anxiety of repayment as there is no fixed repayment date
- Holders also get preference at the time of payment in case of liquidation
- Holder have no voting right. So, they cannot exert power
- Disadvantage:
- It is costly as dividend price is higher than equity
- It is difficult to sell as investors does not like to buy it
- Investors get priority claim in assets and profits
- It is a must to pay dividends
Advantages are more significant than disadvantages. So, the issuance is better for a company
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CALCULATION OF COOGLY’S COST OF COMMON STOCK
Here also flotation cost is deducted from price to reflect the increased cost. Moreover perpetual growth rate is added to it to reflect the growing dividend in the cost
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- Advantage:
- As dividend is not fixed, it creates no new fixed payments initially
- It has no payment date so there is no obligation to pay
- Issuing new equity proves creditworthiness of the company to the lenders
- Disadvantage
- Issuing new equity share dilutes power of existing shareholders
- Equity value per share reduces as number of share increases
- Cost of issuing security is higher than other securities that creates huge one time cost for a company
ADVANTAGE AND DISADVANTAGE OF NEW COMMON STOCK
CALCULATION OF COOGLY’S COST OF DEBT
As debt is tax deductible, tax amount is deducted from the percentage of cost of debt and flotation cost is reduced to reflect increased cost
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ADVANTAGE AND DISADVANTAGE OF NEW DEBT
- Advantage:
- New debt issuance gives tax shield to the company
- It gives signal that the company is expanding
- Issuing new debt does not dilute ownership of the existing
- Disadvantage
- Issuing new debt increases risk of the company
- Timely coupon payment is a must, increases cost of the company
- If asset is kept as collateral if coupon is not paid, assets can be sold for payment due to increase in debt level
- Cost of Preferred Stock Kp= .0526
- Weight of Preferred Stock Wp= .1
- Cost of Common Stock KC=.1627
- Weight of Common Stock Wc=.4
- After tax Cost of Debt Kd=.0387
- Weight of Debt Wd= .3
- WACC = Kp* Wp+ KC*Wc+ Kd* Wd
=(.0526*.1)+(.1627*.4)+(.0387*.3)
= .082 or 8.2%
CALCULATION OF COOGLY’S WACC
As Coogley has no retained earning cost of retained earnings is not included here. Moreover it can be seen equity has highest cost and debt has lowest cost as debt holders have limited right up to loan amount on the company
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ADVANTAGE AND DISADVANTAGE OF WACC IN CAPITAL BUDGETING PROCESS
- Advantage:
- WACC is more appropriate to discount at present value because use of only cost of equity overstates cost where as only use of cost of debt understates cost
- WACC gives appropriate discounted price
- It helps to determine economic flexibility and expansionary opportunities and merger options
- Disadvantage:
- WACC calculation is much complex than it actually seems
- Though WACC is calculated following single way, interpretation can vary person to person and thus create problem in the company
- If market beta increases WACC also increases and thus creates high risk.
THANK YOU