1. FINA 3311: Financial Management Principles
BHH
FINA 3311: Financial Management Principles
Case Study
BHH Inc.
Names & IDs:
Yasmeen Al Jishi
Samar Al Zayer
Sara Al Ismail
Sara Al Zawad
Section: 203 
Instructor: Rashida Sharmin
Fall Semester

2. Information's 1. The firm’s tax rate is 30 percent.
2. The current price of BHH’s 12 percent coupon, semiannual payment, bonds with 10 years remaining to maturity is $1, Bonds have negligible amount of flotation costs.
3. The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $ BHH would incur flotation costs of $2.00 per share on a new issue.
4. BHH’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19 and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. BHH’s beta is 1.30; the yield on T-Bonds is 7 percent; the market return is estimated to be 13%.
5. BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
BHH

3. Common Stock (Equity) Preferred Stock bond (debt)
What sources of capital should be included when you estimate BHH’s weighted average cost of capital (WACC)?
Common Stock (Equity)
Preferred Stock
bond (debt)
BHH

4. What is the market interest rate on BHH’s debt and its component cost of debt?
1. The firm’s tax rate is 30 percent.
2. The current price of BHH’s 12 percent coupon, semiannual payment, bonds with 10 years remaining to maturity is $1, Bonds have negligible amount of flotation costs.
3. The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $ BHH would incur flotation costs of $2.00 per share on a new issue.
4. BHH’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19 and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. BHH’s beta is 1.30; the yield on T-Bonds is 7 percent; the market return is estimated to be 13%.
5. BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
BHH

5. FV= 1000 PV= 1140 PMT= (1000  12%)  2 120  2 = 60 N= 10  2 = 20
What is the market interest rate on BHH’s debt and its component cost of debt?
FV= 1000
PV= 1140
PMT= (1000  12%)  2 120  2 = 60
N= 10  2 = 20
I/Y=?  I/Y = 4.89
(Semiannually)
BHH

6. BHH does not plan to issue new shares of common stock
BHH does not plan to issue new shares of common stock. Using the CAPM approach, what is the BHH’s estimated cost of equity?
1. The firm’s tax rate is 30 percent.
2. The current price of BHH’s 12 percent coupon, semiannual payment, bonds with 10 years remaining to maturity is $1, Bonds have negligible amount of flotation costs.
3. The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $ BHH would incur flotation costs of $2.00 per share on a new issue.
4. BHH’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19 and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. BHH’s beta is 1.30; the yield on T-Bonds is 7 percent; the market return is estimated to be 13%.
5. BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
BHH

7. Kj = Krf  m (Km – Krf) Krf= 0.07  1.30  (0.13 – 0.07) 
BHH does not plan to issue new shares of common stock. Using the CAPM approach, what is the BHH’s estimated cost of equity?
Kj = Krf  m (Km – Krf)
Krf= 0.07  1.30  (0.13 – 0.07) 
0.07  (1.30  0.06) 
0.07  0.078
Krf = 
14.8%
Krf  the rate of return on risk-free securities
m  measure of a stock's volatility relative to the overall market.
Km  the market's overall expected rate of return
BHH

8. What is the estimated cost of equity using the constant dividend growth model?
1. The firm’s tax rate is 30 percent.
2. The current price of BHH’s 12 percent coupon, semiannual payment, bonds with 10 years remaining to maturity is $1, Bonds have negligible amount of flotation costs.
3. The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $ BHH would incur flotation costs of $2.00 per share on a new issue.
4. BHH’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19 and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. BHH’s beta is 1.30; the yield on T-Bonds is 7 percent; the market return is estimated to be 13%.
5. BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
BHH

9. What is the estimated cost of equity using the constant dividend growth model?
Ke = (D1 P0)  g
P0 = 50
g = 0.05
To calculate D1:
D1 = D0  (1  g) 
4.19  (1 0.05) 
4.19  1.05 = 4.39
To calculate Ke:
Ke = (4.39/50)  0.05 
=  0.05
= 0.137
Ke= estimated cost of equity
D1= Dividend for next year
D0= last dividend
P0= price
G= growth
BHH

10. What is BHH’s WACC?
1. The firm’s tax rate is 30 percent. 2. The current price of BHH’s 12 percent coupon, semiannual payment, bonds with 10 years remaining to maturity is $1, Bonds have negligible amount of flotation costs. 3. The current price of the firm’s 10 percent, $100 par value, quarterly dividend, perpetual preferred stock is $ BHH would incur flotation costs of $2.00 per share on a new issue. 4. BHH’s common stock is currently selling at $50 per share. Its last dividend (D0) was $4.19 and dividends are expected to grow at a constant rate of 5 percent in the foreseeable future. BHH’s beta is 1.30; the yield on T-Bonds is 7 percent; the market return is estimated to be 13%. 5. BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
BHH

11. What is BHH’s WACC? WACC = Wd  (Kd)  (1-T)  We  (Ke)  Wp  (Kp)
Kd = YMT  (1-T)  =  (1-0.30)  =  0.7=
Ke = the average cost of equity  (0.137  0.148)/2  /2 = 0.14
Kp = D1/P0-F  4.39/ = 0.039
WACC = .30   .50  .14  .20  .039
  0.07 
WACC =  8.8%
Wd  weight of dividend
Kd  cost of dividend
T  Tax
We  weight of equity
Ke  cost of equity
Wp  weight of preferred stock
Kp  cost of preferred stock
BHH

12. How is any firm’s stock price (or the value of the firm) related to WACC? Explain in words.
Using different finance activities are important to determine equity and debt
The required return on equity and debt differ
The WACC weights the required return on equity and debt so; both the debt and equity should be based on market as total value of the company itself
Evaluate this company as a public company so; the market value of the equity is observable through the stock market
The purpose of a valuation is to estimate the market value of the equity
The value of any the equity is used in the suggestion of WACC and the WACC is used in the calculation of the equity value
BHH

13. As a financial analyst, what could be your suggestion to reduce WACC?
Increase debt/equity ratio of BHH Inc by using more debt than equity
Increase the use of cheaper financing sources
Reduce interest rates on debt
Reduce required return on the company's stock
Reduce debt leads to reduce volatility in this company’s finances and hence, the stock price.
Reduce stress from lower stock price volatility to raise the WACC
BHH

14. References:
Investing answers. (2009). Weighted Average Cost of Capital (WACC). Retrieved 5 Dec, 2012 from dictionary/financial-statement-analysis/weighted- average-cost-capital-wacc WACC Value. (2010). WACC. Retrieved 15 Dec, from
BHH

15. Thank you For Attention
BHH