CORP FIN 51: Using the Payback Method, IRR, and NPV

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WACC#1

Exercise: (From the Cost of Capital Workbook Pratt, Shannon 2nd edition)
A1 The required return on debt is 8%, the required return on equity is 14% and the marginal tax rate is 40%.
If the firm is financed 70% equity and 30% debt , what is the WACC?
Definitions: L=Leverage L=the market value proportion of debt financing
D= Debt
T=marginal corporate tax rate of income from the project
rsub e = required return for equity
rsub d = required return for debt
Set up the problem:
D= 0.4
E= 0.6
rsub e = 0.07
rsub d= 0.09
T= 0.4
L= 0.4
Solution:
L = D / (D + E) = 30% / (30% + 70%) = 0.30
WACC = (1 - L)re + L(1 - T)rd Excel solution:
WACC = (1 - 0.30) x 14% + 0.30(1 - 0.40) x 8% = 11.24% WACC= 0.0636

WACC#2

Exercise: (From the Cost of Capital Workbook Pratt, Shannon 2nd edition)
The following are known about public Company XYZ
4,000,000 million shares of common stock issued and outstanding
$10 Closing common stock price per share
2,000,000 shares of preferred stock issued and outstanding
$16 Closing preferred stock price per share
$10,000,000 Face value of bonds issued and outstanding
$80 Closing Bond Price (80% of face value)
25% Cost of common equity for XYZ
$2.40 Cumulative, non-participating dividend on preferred stock every year
10% Cost of debt before tax effect
40% Combined federal/state income tax rate
Preferred Equity Cost?
15% Because the market price is $16.00 and its dividend per share is $2.40 the
cost is: $2.40/$16.00 = 0.15 or 15%
Excel solution: 0.15
The after -tax cost of debt for Company XYZ is:
6% In the return to debt component, interest is a tax-deductable expense
to a corporate taxpayer. One way to approximate the cost of debt after
taxes or net of the tax effect is to multiply the cost of debt
before tax by (1-tax rate): 10% x (1-0.40) = 0.10 x 0.60 = 6%
Excel solution: 0.06
Compute the market value of invested capital (MVIC) and the weights
for each capital structure component of XYZ.
Component Amount Price Component Total Weight
Common Stock 4000000 $10 $40,000,000 50%
Preferred Stock 2000000 $16 $32,000,000 40%
Debt $10,000,000 0.8 $8,000,000 10%
MVIC $80,000,000 100%
What is the WACC?
WACC= =(25% x 0.50) + (15% x 0.40) + [10%(1-0.40) x 0.10]
=12.5% + 6% + 0.6%
=19.10%
Or in tab form:
Component Cost Weight Weighted Cost
Common Stock 25% 0.5 12.50%
Preferred Stock 15% 0.4 6.00%
Debt 6% 0.1 0.60%
WACC 19.10%

WACC#3

Exercise: (From the Cost of Capital Workbook Pratt, Shannon 2nd edition)
Given the following:
Pretax cost of debt 10%
Cost of preferred stock 9%
Cost of common equity 20%
Shares of common stock 1,000,000
Price per share of common stock $7.00
Shares of preferred stock 500,000
Price per share of preferred stock $4.50
Face value of debt (same as market value) $3,000,000
tax rate 30%
Compute the WACC…
Component Amount Price Component Total Weight
Common Stock 1,000,000 $7 $7,000,000 57.1%
Preferred Stock 500,000 $5 $2,250,000 18.4%
Debt $3,000,000 24.5%
Total: $12,250,000 100%
Component Cost Weight Weighted Cost
Common Stock 0.20 x 57.1% = 0.1142857143
Preferred stock 0.09 x 18.4% = 0.0165306122
Debt 0.10 x (1-0.30)= 0.07 x 24.5% = 0.0171428571
100.0% 0.1479591837 = 14.80%
WACC = 14.80%