Cost of Capital 1. Hilliard Corp. wants to calculate its weighted average cost of capital (WACC). The company’s CFO has collected the following information: The company’s long-term bonds currently offer a yield to maturity of 8 percent. The company’s stock price is $32 a share (P0 = $32). The company recently paid a dividend of $2 a share (D0 = $2.00). The dividend is expected to grow at a constant rate of 6 percent a year (g = 6%). The company pays a 10 percent flotation cost whenever it issues new common stock (F = 10 percent). The company’s target capital structure is 75 percent equity and 25 percent debt. The company’s tax rate is 40 percent. The firm will be able to use retained earnings to fund the equity portion of its capital budget. What is the company’s WACC?

Cost of Capital Before tax cost of debt =8% Cost of retained earnings=2*1.06/32+6% = 12.625% cost of a new issue of common stock = (2*1.06)/(32*(1-10%))+6% = 13.36% WACC=0.75*12.625%+0.25*8%*(1-40%)=10.67%

Cost of Capital 2. A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions. Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40. Preferred Stock: The firm has determined it can issue preferred stock at $75 per share . The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at A rate of 2.73% for the last four years. It is expected that floatation costs will be $1 per share Additionally, the firm's marginal tax rate is 40 percent.

Cost of Capital The firm's before-tax cost of debt is 7.79 percent. The firm's after-tax cost of debt is 4.67 percent. The firm's cost of preferred stock is 13.9 percent. The firm's cost of a new issue of common stock is 12.97 percent. The firm's cost of retained earnings is 12.4 percent. The weighted average cost of capital up to the point when retained earnings are exhausted is 11.0 percent. The weighted average cost of capital after all retained earnings are exhausted is 11.4 percent.

Raising Capital 3. Electrical Services, Inc. would like to expand its operations and would require $2 million in additional funding to do this. After discussing this with shareholders, Electrical Services has decided to raise the necessary funds through a rights offering with a subscription price of $24 a share. The current market price of their stock is $30 a share. How many shares of stock will Electrical Services need to sell through the rights offering to fund the expansion plans?  Answer: 83,333 shares

Raising Capital 4. Winning Sportswear wants to raise $3 million through a rights offering to renovate their current facilities. The subscription price for the offering is set at $20 a share. Currently, the company has 120,000 shares of stock outstanding at a market price of $25 a share. Each shareholder will receive one right for each share of stock they own. How many rights will be needed to purchase one new share of stock in this offering?  Rights needed for each new share = 0.80 rights

Raising Capital New shares=3M/20=150,000 120,000 rights to buy 150,000 new shares 0.80 rights to buy 1 new share Rights needed for each new share = 0.80 rights

Raising Capital 5. Hamilton, Inc. is issuing a rights offering wherein every shareholder will receive one right for every share of stock they own. The new shares in this offering are priced at $30 plus 2 rights. The current market price of Hamilton, Inc. stock is $34.50 a share. What is the value of one right?  Value of one right = $1.50

Raising Capital N old shares N/2 new shares Value of Equity = N*34.5+(N/2)*30 New share price = (N*34.5+(N/2)*30)/(3N/2) = 49.5/1.5 = 33 30+2*VR=33 Value of one right = $1.50

Working with Financial Statements 6. The Purple Martin has annual sales of $687,400, total debt of $210,000, total equity of $365,000, and a profit margin of 5.20 percent. What is the return on assets?  ROA = (.0520  $687,400)/($210,000 + $365,000) = 6.22 percent  

Working with Financial Statements 7. Lancaster Toys has a profit margin of 9.6 percent, a total asset turnover of 1.71, and a return on equity of 21.01 percent. What is the debt-equity ratio?    Equity multiplier = .2101/(.096  1.71) = 1.28 Debt-equity ratio = 1.28 - 1 = 0.28

Financial Planning  8. Country Comfort, Inc. had equity of $150,000 at the beginning of the year. At the end of the year, the company had total assets of $195,000. During the year, the company sold no new equity. Net income for the year was $72,000 and dividends were $44,640. What is the sustainable growth rate? 

Financial Planning where Ending equity = $150,000 + ($72,000 - $44,640) = $177,360 Return on equity = $72,000/$177,360 = 0.4060 Retention ratio = ($72,000 - $44,640)/$72,000 = 0.38 Sustainable growth rate = (0.4060  0.38)/[1 - (0.4060  0.38)] = 18.24 percent

Financial Planning  9. A firm wishes to maintain an internal growth rate of 11 percent and a dividend payout ratio of 24 percent. The current profit margin is 10 percent and the firm uses no external financing sources. What must the total asset turnover rate be? 

Financial Planning Retention ratio = 1 - 0.24 = 0.76 Internal growth rate = 0.11 = (ROA  0.76)/[1 - (ROA  0.76)] Solve for ROA = 0.1304 = 0.1304 = 0.10  TAT; Total asset turnover = 1.30 times

Financial Planning  10.  Fixed Appliance Co. wishes to maintain a growth rate of 8 percent a year, a constant debt-equity ratio of 0.34, and a dividend payout ratio of 52 percent. The ratio of total assets to sales is constant at 1.3. What profit margin must the firm achieve? 

Financial Planning Retention ratio = 1 - 0.52 = 0.48 Sustainable growth rate = 0.08 0.08 = (ROE  0.48)/[1 - (ROE  0.48)] Solve for ROE = 0.1543 = 0.1543 = PM  (1/1.3)  (1 + 0.34) Profit margin = 14.97 percent

Financial Planning   11. Seaweed Mfg., Inc. is currently operating at only 81 percent of fixed asset capacity. Current sales are $550,000. What is the maximum rate at which sales can grow before any new fixed assets are needed?   

Financial Planning Full capacity sales = $550,000/0.81 = $679,012 Maximum sales growth = (679,012/$550,000) – 1 = 23.46 percent    

Financial Planning   12. The most recent financial statements for 7 Seas, Inc. are shown here: Assets, costs, and current liabilities are proportional to sales. Long- term debt and equity are not. The company maintains a constant 50 percent dividend payout ratio. Like every other firm in its industry, next year's sales are projected to increase by exactly 16 percent. What is the external financing need?   

Financial Planning External financing need = $13,069.72 - $11,827.96 = $1,241.76