The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is only an appropriate discount rate for a project of average risk-in other words, a project that has the same beta as the company. If a project has less risk than the overall company risk, it should be evaluated with a lower discount rate; if a project is riskier than the overall company risk, it should be evaluated using a discount rate higher than the company WACC. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 40%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Do not round your intermediate calculations.) The WACC is used as the discount rate to evaluate various capital budgeting projects. However, it is important to realize that the WACC is only an appropriate discount rate for a project of average risk-in other words, a project that has the same beta as the company. If a project has less risk than the overall company risk, it should be evaluated with a lower discount rate; if a project is riskier than the overall company risk, it should be evaluated using a discount rate higher than the company WACC. Analyze the cost of capital situations of the following company cases, and answer the specific questions that finance professionals need to address. Consider the case of Turnbull Co. Turnbull Co. has a target capital structure of 58% debt, 6% preferred stock, and 36% common equity. It has a before-tax cost of debt of 8.2%, and its cost of preferred stock is 9.3%. If Turnbull can raise all of its equity capital from retained earnings, its cost of common equity will be 12.4%. However, if it is necessary to raise new common equity, it will carry a cost of 14.2%. If its current tax rate is 40%, how much higher will Turnbull's weighted average cost of capital (WACC) be if it has to raise additional common equity capital by issuing new common stock instead of raising the funds through retained earnings? (Note: Do not round your intermediate calculations.)
Expert Answer:
Answer rating: 100% (QA)
Calculate how much higher Turnbulls weighted average cost of capital WACC will be if it has to raise ... View the full answer
Related Book For
Fundamentals of Financial Management
ISBN: 978-0324664553
Concise 6th Edition
Authors: Eugene F. Brigham, Joel F. Houston
Posted Date:
Students also viewed these finance questions
-
Evaluate the effectiveness of the Dodd-Frank Act in addressing systemic risks and enhancing financial stability in the aftermath of the 2008 financial crisis. How have regulatory reforms, such as...
-
In the basic EOQ model, if EOQ = 100 per year, S = $100, and holding cost = $8 per unit per month, what is demand per month? O 9600 O 6000 4800 400 O 490
-
Planning is one of the most important management functions in any business. A front office managers first step in planning should involve determine the departments goals. Planning also includes...
-
SG Company acquired 80% of Popsters Company on January 1, 2019, when the stockholders equity of Popsters consisted of: Ordinary shares, P100 par P500,000 Paid in capital in excess of par 400,000...
-
At the initial moment the activity of a certain radionuclide totaled 650 particles per minute. What will be the activity of the preparation after half its half-life period?
-
Can you think of a real-world situation where a high central tendency measure masked significant dispersion in public opinion, leading to unexpected outcomes or challenges for a political leader or...
-
A milk processing unit claims that, of the processed milk converted to powdered milk, \(95 \%\) does not spoil. Find the probabilities that among 15 samples of powdered milk (a) all 15 will not...
-
Goldencoast Industries uses standard costing and a flexible budget for cost planning and control. Its monthly budget for overhead costs is $100,000 of fixed costs plus $5 per machine hour. Monthly...
-
16 ! Required information 2.77 points eBook Print References [The following information applies to the questions displayed below.] Chuck Wagon Grills, Incorporated, makes a single product-a handmade...
-
You are the manager of the Mighty Fine mutual fund. The following table reflects the activity of the fund during the last quarter. The fund started the quarter on January 1 with a balance of $40...
-
As the auditor for Cooper Corporation, you elect to use statistical sampling in performing tests of controls over purchase transactions. You perform the five following tests of internal controls....
-
Pamela's salary in 2017-18 is 105,000. She has no other income for the year and she is not a Scottish taxpayer. (a) Calculate her income tax liability for 2017-18. (b) Re-calculate her income tax...
-
Rose is single and has total income of 11,250 in 2017-18. She makes a gross deductible payment of 25 during th e year. Show her income tax computation for the year and determine the amount of tax...
-
Simon owns an apartment which he lets to tenants. The apartment was let throughout tax year 2017-18 at a weekly rental of 320. The expenses incurred by Simon in relation to this apartment during...
-
Toby is a widower. He was born in August 1932. His wife was born in June 1933 but she died in March 2017. Toby's income for 2017-18 is as follows: 10,480 912 Retirement pension Income from purchased...
-
Matthew (who was born on 1 May 1934) dies on 23 December 2017. His only income in tax year 2017 -18 is a retirement pension of 2 9,260. H e made a Gift Aid donation of 200 in July 2017. His wife has...
-
What is Data Reduction & Explain Techniques used in data reduction.
-
You have just begun your summer internship at Omni Instruments. The company supplies sterilized surgical instruments for physicians. To expand sales, Omni is considering paying a commission to its...
-
Trivoli Industries plans to issue perpetual preferred stock with an $11.00 dividend. The stock is currently selling for $97.00; but flotation costs will be 5% of the market price, so the net price...
-
Using the Hamada equation, what is the cost of equity if CD recapitalizes with $250,000 of debt? $500,000? $750,000? $1,000,000?
-
A firm has a profit margin of 2% and an equity multiplier of 2.0. Its sales are $100 million, and it has total assets of $50 million. What is its ROE?
-
A stock price is governed by \[\frac{\mathrm{d} S}{S}=\mu \mathrm{d} t+\sigma \mathrm{d} z\] where \(z\) is a standardized Wiener process. Interest is constant at rate \(r\). An investor wishes to...
-
At the beginning of April one year, the silver forward prices (in cents per troy ounce) were as follows: The carrying cost of silver is about 20 cents per ounce per year, paid at the beginning of...
-
Suppose that a forward contract on an asset is written at time zero and there are \(M\) periods until delivery. Suppose that the proportional carrying charge in period \(k\) is \(q S(k)\), where...
Study smarter with the SolutionInn App