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Problem Intro

FN300 Finance LOA
Problem Introduction Tab
This financial planning project is split into several parts
Each section has its own tab.
Section
Problem Introduction TAB
This tab
Gustafson Financial Information TAB
You will find all the given data here
1 Cost of Capital : Capital Structure TAB
This section is split into two tabs: Cost of Capital A and Cost of Capital B
Cost of Capital A concentrates on the developing Gustafson Capital Structure
Problem:
a) Calculate the firm's capital structure based on book and market values and compare with the target capital structure.
2 Cost of Capital: WACC TAB
Cost of Capital B concentrates on calculating Gustafson's WACC
b) Calculate the cost of debt based on the market return on the company's existing bonds.
c) Calculate the cost of preferred stock based on the market return on the company's existing preferred stock
d) Calculate the cost of retained earnings using three approaches, CAPM, dividend growth, and risk premium.
Reconcile the results into a single estimate
e) Estimate the cost of equity raised through the sale of new stock using the dividend growth approach
f) Calculate the WACC using equity from retained earnings based on your component cost estimates and the target capital structure
3 Capital Rationing: Finding the Breakpoints TAB
This section calculate the breakpoints
g) Where is the first breakpoint in the MCC (the point where retained earnings runs out)? Calculate to the nearest $.1M.
h) Calculate the WACC after the first breakpoint.
i) Where is the second breakpoint in the MCC (the point at which the cost of debt increases.)
j) Calculate the WACC after the second break. Calculate to the nearest $0.1M.
4 MCC - IOS Plot TAB
In this section we plot the Marginal Cost of Capital and the Investment Opportunity Schedule
This tab MCC-IOS is to be used as a template for your graphs
Use the Commands Insert>line and Insert>rectangle to create your plot
k) Plot Gustafson's Marginal Cost of Capital.
l) Plot Gustafson's IOS on the same axes as the MCC.
5 Capital Planning TAB
In this section, we analyze our data and make our conclusions
m) Which projects should be accepted and which should be rejected?
n) Do any of those rejected have IRRs above the initial WACC? Which ones?
o) If so, explain in words why they're being rejected.
p) What is the WACC for the planning period?
Answers are to be entered in the black outlined, yellow boxes
Supporting data is to be entered in the underlined yellow boxes.
Enter all percentages as decimals

Gustafson Financial Information

Gustafson Gutters Financial Data
Debt
issued 18,000 30 year bonds 10 years ago
at $ 1,000.00 par value with 5% coupon rate
similar bonds now selling at 4%
Preferred Stock
issued 20,000 shares 6 years ago
at $ 100.00 par value
with dividend of $6
similar preferred issues are now selling at 5%
Equity
issued 2,300,000 shares at $ 9.50
Accumulated retained earning is now $ 5,000,000.00
stock closed at $ 11.25
Torborg's Target Capital Structure
Debt 35%
Preferred 5%
Equity 60%
Additional Financial Information
Marginal Tax Rate 35%
Floatation coasts average 11% for both common and preferred stock
Short Term Treasury yields 2.5%
Market return is 8.5%
Gustafson beta is 0.9
Indefinite expected growth: 3%
Last annual dividend $ 0.50 per share
Expected next years' earnings $ 5,000,000.00
Firm can borrow up to $ 1,500,000.00 at market return of old debt
lenders will demand 7% for borrowing beyond
Investment Opportunity Schedule
Project IRR Capital Requirement
A 14% $ 3,000,000.00
B 8% $ 2,500,000.00
C 6% $ 2,000,000.00
D 5% $ 1,000,000.00

Cost of Capital Capital Structu

Cost of Capital: Capital Structure TAB
score
A Calculate the firm's capital structure based on book and market values and compare with the target capital structure.
Debt:
Book Value
of Debt Number of Bonds Issued Bond Face Value
2 = X
Market Value
of Debt = ( PMT X PVFA(k,n) + FV x PVF(k,n) ) X Number of Bonds Issued
2 = ( X + x ) X
k =
n =
Preferred:
Book Value of Preferred Stock
Preferred Stock = Face Value X Preferred Stock Issued
2 = X
PV of a Perpetuity (Dp/k)
Market Value of Preferred
Preferred Stock = ( Dividend (Dp) / Market Rate (k) ) X Stock Issued
2 = ( / ) X
Equity:
Book Value of Common Issue Retained
Equity = ( Stock issued X Price ) + Earnings
2 = ( X ) +
Market Value of Common Market Retained
Equity = ( Stock issued X Price ) + Earnings
2 = ( X ) +
Part 1
page 2 Cost of Capital
Capital Structure Comparison:
Book Market Target
Value Weight Value Weight Weights
Debt 35%
Preferred 5%
Equity 60%
6 total 100%
Comments:
3
Total
21

Cost of Capital WACC

Cost of Capital: Weighted Average Cost of Capital TAB
points
B Calculate the cost of debt based on the market return on the company's existing bonds.
Cost Market Tax
of = yield X ( 1 - Rate )
Debt (kd) (T)
2 = X ( 1 - )
C Calculate the cost of preferred stock based on the market return on the company's existing preferred stock
Cost of Market Floatation
Preferred = Rate / ( 1 - Rate )
Stock (Kp) (f)
2 = / ( 1 - )
D Calculate the cost of retained earnings using three approaches, CAPM, dividend growth, and risk premium. Reconcile the results into a single estimate
CAPM:
Cost of Risk Free Market Risk Free
Retained = Rate + ( Return - Rate ) X beta
Earnings (krf) (km) (krf) (bx)
2 = + ( ) X
Dividend Growth:
Cost of Latest Growth Stock Growth
Retained = ( Dividend X ( 1 + Rate ) / Price ) + Rate
Earnings (D0) g P0 g
2 = ( X ( 1 + ) / ) +
Risk Premium:
Cost of Bond Risk
Retained = Yield + Premium
Earnings kd rpe
2 = +
Reconciliation
2
E Estimate the cost of equity raised through the sale of new stock using the dividend growth approach
Cost of New Latest Growth Floatation Stock Growth
Common = ( Dividend X ( 1 + Rate ) ) / ( ( 1 - Rate ) X Price ) + Rate
Stock (D0) g (f) P0 g
2 = ( X ( 1 + ) ) / ( ( 1 - ) X ) +
F Calculate the WACC using equity from retained earnings based on your component cost estimates and the target capital structure
Target Cost Factors
Weights
Debt 35%
Preferred 5%
6 Common Equity 60%
3 WACC
Total
23

Capital Rationing

Capital Rationing: Calculating Breakpoints TAB
points
g Where is the first breakpoint in the MCC (the point where retained earnings runs out)? Calculate to the nearest $.1M.
Dividends:
Common Dividend Common
Dividends = per share X Stock issued
2 = X
Preferred Dividend Preferred
Dividends = per share X Stock issued
2 = X
Retained Total
Earnings = Earnings - Dividends
2 = -
Retained Target
Breakpoint = Earnings / Weight
2 = /
h Calculate the WACC after the first breakpoint.
Target Cost Factors
Weights
Debt 35%
Preferred 5%
Equity 60%
2
i Where is the second breakpoint in the MCC (the point at which the cost of debt increases.)
Additional Target
Breakpoint = Lending Available / Weight
2 = /
j Calculate the WACC after the second break. Calculate to the nearest 0.1%.
Target Cost Factors
Weights
Debt 35%
Preferred 5%
6 Equity 60%
3
Total
21

MCC - IOS Plot

MCC - IOS Plot TAB
points
10 k Plot Gustafson's MCC.
10 l Plot Gustafson's IOS on the same axes as the MCC.
16% Gustafson Marginal Cost of Capital and Investment Opportunity Schedule
14%
12%
10%
8%
Cost of Capital 6%
4%
2%
$2M $4M $6M $8M $10M $12M
Total Capital Raised
Total
20

Capital Plan

Capital Planning TAB
points
m Which projects should be accepted and which should be rejected?
5
n Do any of those rejected have IRRs above the initial WACC? Which ones?
5
o If so, explain in words why they're being rejected.
5
Total
15