You have recently been hired as a financial analyst for a children's toy manufacturing company. The company
Question:
You have recently been hired as a financial analyst for a children's toy manufacturing company. The company is growing and has the capital to invest in expansion projects. Management asks you to do a cost of capital analysis to be able to use the right discount rate in its NPV calculations to assess the relevance of projects. You are asked for the cost of equity using the dividend growth model. You have the following information about the company:
The company's stock is trading at $52.90 right now. The dividend paid this year to shareholders totals $1.45. In previous years, dividends have experienced stable historic growth. You have the following historical data to estimate the annual growth rate of the dividend:
Current year: $1.45
Last year: $1.40
2 years ago: $1.36
3 years ago: $1.27
4 years ago: $1.25
The company also uses debt to meet its investment needs. The company has an operating line of credit (short-term loan) with its financial institution and the interest rate on this line of credit is variable (base rate + 1% - for the current year this rate represents 3.5%). There is also a long-term loan which bears interest at 6.5%. Also, a series of bonds were issued a few years ago and the maturity of these bonds is scheduled for 23 years. The semi-annual coupons are 4.5% and these bonds are traded on the market at a premium to the index of 103.5. Note that the corporate tax rate is around 30%.
Indebtedness and equity break down as follows on the company's last balance sheet: the balance of the line of credit was $3.6 million; the term loan is $8.6 million; The nominal value of the bond debt totals $12 million (we had issued 12,000 bonds at a nominal value of $1,000 each); the book value of common shares issued several years ago is $25 per share and there are 1 million shares outstanding.
a) Calculate the cost of debt (5 points)?
b) Calculate the cost of equity (5 points)?
c) Calculate the weighted average cost of capital based on the book value of the sources of capital (5 points)?
d) Calculate the weighted average cost of capital based on the market value of the sources of capital (5 points)?
Managerial Accounting
ISBN: 978-0077522940
15th edition
Authors: Ray Garrison, Eric Noreen, Peter Brewer