A Bad Boys Inc Is Evaluating Its Cost Of Capital Under Consu

Question

A Bad Boys Inc Is Evaluating Its Cost Of Capital Under Consultatio A Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees a growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital? B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys cost of capital? C. On page 457, your textbook details the term Cannibalization. In your own words, identify two corporations that have dealt with cannibalization and what steps were taken to overcome the cannibalization. Please provide any citations and references. Please be articulate in your responses.

Dr. Jack HW Helper · Accepted Answer

Introduction Understanding the cost of capital is fundamental for corporations as it influences investment decisions, valuation, and overall corporate strategy. In this paper, we analyze the components involved in calculating Bad Boys, Inc.'s cost of capital, considering different capital structures, and examine the concept of cannibalization with real-world examples. Through comprehensive calculations and case analyses, this discussion aims to elucidate key financial principles relevant to strategic decision-making. Calculation of Cost of Equity The cost of equity is typically estimated using the dividend discount model (DDM), especially when dividends are expected to grow at a constant rate. The formula is: $$ \text{Cost of Equity} (r_e) = \frac{D_1}{P_0} + g $$ Where: - $ D_1 $ = dividend next year = $1.50 - $ P_0 $ = current stock price = $20.00 - $ g $ = dividend growth rate = 5% or 0.05 Applying the values: $$ r_e = \frac{1.50}{20.00} + 0.05 = 0.075 + 0.05 = 0.125 \text{ or } 12.5\% $$ This indicates that the expected return required by investors on the company's equity is 12.5%. Cost of Debt Calculation The cost of debt is straightforward, given the coupon rate of 8% on new debt issued at par: $$ r_d = 8\% $$ Since interest expense is tax deductible, the after-tax cost of debt is: $$ r_{d, after-tax} = r_d \times (1 - \text{Tax rate}) = 8\% \times (1 - 0.35) = 8\% \times 0.65 = 5.2\% $$ Cost of Preferred Stock Preferred stock dividends are fixed, and the cost is calculated as: $$ r_{ps} = \frac{\text{Dividend per share}}{\text{Price per share}} = \frac{2.50}{25} = 0.10 \text{ or } 10\% $$ Weighted Average Cost of Capital (WACC) Calculations The formula for WACC is: $$ \text{WACC} = (w_e \times r_e) + (w_p \times r_{ps}) + (w_d \times r_{d, after-tax}) $$ Where: - $ w_e $, $ w_p $, and $ w_d $ are the weights of equity, preferred stock, and debt respectively. Part A: - $ w_d = 45\% $ - $ w_p = 5\% $ - $ w_e = 50\% $ Applying the weights: \[ W

A Bad Boys Inc Is Evaluating Its Cost Of Capital Under Consu

A Bad Boys Inc Is Evaluating Its Cost Of Capital Under Consultatio

Paper For Above instruction

Introduction

Calculation of Cost of Equity

Cost of Debt Calculation

Cost of Preferred Stock

Weighted Average Cost of Capital (WACC) Calculations

Part A:

Part B:

Cannibalization: Concepts and Corporate Cases

Coca-Cola and New Product Launches

Apple Inc. and Product Line Expansion

Overcoming Cannibalization

Conclusion

References