# Cost of Capital

Answers to Warm-Up Exercises

E9-1. Solution: Weighted average cost of capital N 10, PV 20 dollars, 000 (1 0. 02) $19, 600, PMT Resolve for My spouse and i 8. thirty percent 0. 08 $20, 1000 $1, six hundred, FV 20 dollars, 000

E9-2. Cost of desired stock Response: The cost of favored stock is the ratio in the preferred stock dividend towards the firm's net proceeds from the sale of the recommended stock. rp Dp Np rp (0. 15 $35) ($35 $3) rp $5. 25 $32 16. 4% E9-3. Expense of common inventory equity Answer: The cost of prevalent stock fairness can be found by simply dividing the dividend anticipated at the end of year you by the current price of the stock and adding the expected development rate. rs (D1 P0) g rs ($6. 60 $78) seven percent 15. 33% E9-4. Measured average cost of capital (0. 35 zero. 08) (0. 65 0. 13) 0. 0280 (0. 35 zero. 0845 0. 106) eleven. 25% zero. 0832 eight. 32% Response: ra

E9-5. Weighted normal cost of capital Answer: ra (0. fifty five 0. 067) (0. 10 0. 092)

Solutions to Concerns

P9-1. Idea of cost of capital LG you; Basic a. The firm is basing its decision on the cost to finance a particular project rather than the firm's combined cost of capital. This decision-making method may lead to erroneous accept/reject decisions. ra wd rd we all re ra 0. forty five (7%) zero. 60(16%) ra 2 . 8% 9. 6% ra doze. 4% Reject project 263. Accept task 264. Contrary conclusions had been drawn making use of the two decision criteria. The overall cost of capital as a criterion provides better decisions since it takes into mind the long-run interrelationship of financing decisions.

b.

c. d.

P9-2.

Cost of financial debt using both equally methods LG 3; Advanced a. Net proceeds: Nd $1, 010 Nd $980 $30

n.

Cash goes:

T zero 1вЂ“15 12-15

CF dollar 980 120 1, 1000

c.

Expense to maturity: N 15, P 980, PMT a hundred and twenty, FV 1, 000 Resolve for My spouse and i: 12. thirty percent After-tax expense: 12. thirty percent (1 zero. 4) 7. 38% m. Approximate before-tax cost of financial debt

$120 rd

($1, 1000 $980) 12-15 ($980 $1, 000) 2

rd $121. 33 $990, 000 rd 12. 26% Approximate after-tax cost of personal debt e.

12. 26%

(1

0. 4)

7. 36%

The advantages from the calculator technique are apparent. There are fewer keypunching cerebral vascular accidents and one gets the genuine cost of debt financing. However , the estimation formula is pretty accurate and expedient inside the absence of monetary calculator.

P9-3.

Before-tax cost of debt and after-tax cost of debt LG ELECTRONICS 3; Easy a. In 10, PHOTO VOLTAIC 930 (an expenditure), PMT 0. 6(1, 000) 60, FV 1, 000 Fixing for I 7. 00% b. Utilize the model: After-tax cost of debt before-tax cost of debt (1 tax bracket) 7. 0% (1 zero. 2) your five. 6%

P9-4.

Cost of financial debt using the estimation formula: LG 3; Simple

I rd

$1, 1000 N deb n In d $1, 000 a couple of

ri

rd

(1

T)

Bond A

$90 rd

$1, 1000 $955 20 $955 $1, 000 two

(1 zero. 40)

$92. 25 $977. 50

5. 66%

on the lookout for. 44%

ri 9. 44% Bond M

$100 rd

$1, 500 $970 18 $970 $1, 000 a couple of

(1 0. 40)

$101. 88 15. 34% $985

6. twenty percent

ri 12. 34% Relationship C

$120 rd

$1, 000 $955 15 $955 $1, 500 2

(1 0. 40)

$123 doze. 58% $977. 50

six. 55%

ri 12. 58% Bond D

$90 rd

$1, 500 $985 25 $985 $1, 000 two

(1 zero. 40)

$90. 60 $992. 50

your five. 48%

on the lookout for. 13%

ri 9. 13% Bond E

$110 rd

$1, 500 $920 twenty-two $920 $1, 000 2

(1 zero. 40)

$113. 64 eleven. 84% $960

7. 10%

ri P9-5.

11. 84%

Cost of financial debt using the approximation formula LG 3; More advanced

I rd

$1, 500 N d n N d $1, 000 two

ri

rd

(1

T)

Alternative A

$90 rd

$1, 500 $1, 220 16 $1, 220 $1, 000 2

$76. 25 $1, 128

6. ??????

ri 6th. 87% (1 0. 40) 4. 12% Calculator: D 16, PHOTO VOLTAIC $1, 230, PMT Solve for I actually: 6. 71% After-tax expense of debt: four. 03% Alternate B

$90, FV

$1, 000

seventy dollars rd

$1, 000 $1, 020 a few $1, 020 $1, 1000 2

$66. 00 $1, 010

6. 54%

ri 6. 54% (1 zero. 40) three or more. 92% Calculator: N a few, PV $1, 020, PMT Solve intended for I: six. 52% After-tax cost of debt: 3. 91% Alternative C

$70, FV

$1, 000

$60 rd

$1, 000 $970 7 $970 $1, 000 a couple of

$64. 29 $985

6. 53%

ri 6. 53% (1 zero. 40) several. 92% Calculator: N several, PV $970, PMT Solve for I: 6. 54% After-tax cost of debt: several. 93% Alternate D

$60, FV

$1, 000

$50 rd

$1, 000 $895 10 $895 $1, 000 2

$60. 50 $947. 50

six. 39%

ri 6. 39% (1 0. 40) several. 83% Calculator: N 10, PV...

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