1. Financial Management Principles Group project
Amani AlAhmadi Noor AlShwaikhat Haneen AlFarwan Gufran Al- Baqal

2. Case study
You are a financial analyst in BHH Inc. During the last few years, BHH Inc. has been too constrained by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, and the company has decided to look seriously at a major expansion program that had been proposed by the marketing department. Assume that you are an assistant to Jerry Price, the financial vice president. Your first task is to estimate BHH’s cost of capital. Price has provided you with the following data, which he believes may be relevant to your task:
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.

3. Jerry Price has asked you …?
What sources of capital should be included when you estimate BHH’s weighted average cost of capital (WACC)?
answer : All capital sources :
- common stock - preferred stock - bonds

4. What is the market interest rate on BHH’s debt and its component cost of debt?
By using task #1 ,2 1- The firm’s tax rate is 30 percent 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. Given: PV= -$1,140 FV=$1,000 PMT = 12%/ 2 because semi-annual = 6% = .06 N= 10*2 = 20 because semi-annual YTM= ?
YTM= 4.89 ~ 4. 9 % After-tax cost of Debt = Yield (1-tax rate) = 4.9 % ( 1- 30%) = 4.9% * = 3.43%

5. CAMP : kj = krf + j (km - krf ) Kj = 7%+ 1.30 (13%-7%)
BHH does not plan to issue new shares of common stock. Using the CAPM approach, what is the BHH’s estimated cost of equity?
By using task 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%.”
Given : Rf= 7% B = 1.3 Km = 13%
CAMP : kj = krf j (km - krf )
Kj = 7% (13%-7%)
Cost of equity estimated = 14.8%
where:
kj = the required return on security = ?
krf = the risk-free rate of interest= 7%
B = the beta of security = 1.3
km = the return on the market index = 13%

6. What is the estimated cost of equity using the constant dividend growth model?
By using task 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%.”
Given : D0 = 4.19 $ g = 5% P0 = 50
The cost of equity could be calculated using the constant dividend growth model using the following formula:
Ke = (D1 / P0 +g ) before calculate the Cost of common equity in the form of retained earnings we should find D1
D1 = D0 ( 1+g) = 4.19 ( 1+5%) = 4.40 $ So : Ke = (D1 / P0 +g ) = 4.40 / 50 +5% = 4.40 / =
Cost of common equity = 8.79 %
Ke = Cost of common equity in the form of retained earnings
D1 = Dividend at the end of the first year
P0 = Price of stock today
g = Constant growth rate in dividends

7. What is BHH’s WACC? Where,
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 BHH’s target capital structure is 30 percent long term debt, 20 percent preferred stock, and 50 percent common equity.
WACC is calculated using the following formula:
WACC= Wd(Kd)(1-t)+(Wp)(Kp) +(We)(Ke)
Where,
Wd= The proportion of the financing taken on by debt = 30%
The Wp= The proportion of the financing taken provided by preferred stock = 20%
The We= The proportion of the financing provided by common equity = 50%
Kd= YTM * ( 1- tax rate) = 4.9%* (1-30%) = 3.43%
The Kp= D1 / (P0 – F) +g = 4.40 / ( 50-2) +5% = 14.16%
The Ke= 14.8% from (c )

8. Therefore:
WACC = (30%) ( 3.43%) (1-30%) + (20%)(14.16%) + (50%)( 14.8%) =
WACC=10.95%

9. How is any firm’s stock price (or the value of the firm) related to WACC? Explain in words
A firm’s value is related to the WACC of the firm because WACC, by definition, is the minimum rate of return required to create value for a specific firm. Because the WACC is the overall required return on the firm as a whole, it is often used as the discount rate for the valuation of cash flows with risk that is similar to that of the overall firm. Therefore, to value a firm’s cash flows, whether it was for acquisition or merger purposes, managers often used the WACC as the discount rate. WACC is related to the value of the firm because the higher the WACC, the lower the value of the firm and the lower the WACC, the higher the value of the firm.

10. As a financial analyst, what could be your suggestion to reduce WACC?
One way to decrease WACC is to use more debt than equity because debt is tax deductible. However it is important to note that too much debt makes a company more risky and will cause the stock component of WACC to increase to compensate for the high risk.

11. Another option for a financial analyst for reducing WACC is issuing more preferred stock than common stock because preferred stock is less expensive than common stock. Issuing preferred stock normally is less expensive than issuing common equity, because common shareholders are the last in line for company earnings, having the ultimate responsibility for a company's failure and thus requiring higher rate of return. But using the less expensive preferred stock instead of common equity is not always an easy choice, because a company would then be obligated to pay preferred dividends. Even though a company can suspend the dividends when necessary, it must promise to make that up later. If a company decides to issue more preferred stock than common equity, the issuance can potentially lower the company's WACC at the time. Therefore, the immediate benefit of lowering WACC from issuing preferred stock may disappear over time, and WACC may go up gradually.

12. Another way a financial analyst can decrease WACC is lowering the cost of equity by lowering the beta of the company by using risk management techniques. This method is often more difficult to implement than the previous method and usually takes a longer, but reducing the risk of the firm and thus the firm’s stock, could potentially decrease WACC.