STEP 4 – Cost of Capital

STEP 4 – Cost of Capital

The firm decides to raise $30 million by selling equity and debt. The investment bankers hired by your firm contact potential investors and come back with the following numbers:

• Debt that pays $1 million coupons a year and      $18 million maturity value after 10 years will sell for $20 million. 
• Equity that pays expected dividends of $1.2      million starting next year and growing at a rate of 3 percent per year      thereafter sells for $10 million. 

Question 12: Calculate the cost of debt, equity, and the WACC.

Be sure to show all your calculations in Excel and provide a narrative analysis in Excel. Your narrative analysis should summarize the results of your analysis and make recommendations for the benefit of company.

Before you submit your assignment, review the competencies below, which your instructor will use to evaluate your work.  A good practice would be to use each competency as a self-check to confirm you have incorporated all of them in your work.

• 3.1 Identify numerical or mathematical      information that is relevant in a problem or situation.
• 3.2 Employ mathematical or statistical      operations and data analysis techniques to arrive at a correct or optimal      solution.
• 3.3 Analyze mathematical or statistical      information, or the results of quantitative inquiry and manipulation of      data.
• 3.4 Employ software applications and analytic      tools to analyze, visualize, and present data to inform decision-making.
• 10.3 Determine optimal financial decisions in      pursuit of an organization's goals.
• 10.4 Make strategic managerial decisions for      obtaining capital required for achieving organizational goals.

Additional Guidance on Project 4

Q12. Calculate the cost of debt, which is similar to the interest rate. Therefore, calculate the interest rate.

Use the perpetuity to derive the cost of equity. Make r = rate, the subject of the equation.

WACC then is computed as ---- proportion of capital structure * cost of debt + proportion of capital structure * cost of equity