Homework Set 4: Chapters 9, 10, 11 Due Week 8 And Worth 100

Homework Set 4 Chapters 9 10 11due Week 8 And Worth 100 Points

Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above.

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.

Paper For Above instruction

The evaluation of a company's cost of capital is a fundamental component of corporate finance, serving as a critical benchmark for investment decisions, project appraisals, and valuation. Bad Boys, Inc. provides an illustrative case of how firms assess their financial costs, considering different capital structures and their implications on overall cost of capital. Additionally, understanding issues like cannibalization informs strategic planning, notably in product line expansions and new product launches. This paper explores both these financial concepts through detailed analysis and real-world examples.

Calculating the Cost of Capital for Bad Boys, Inc.

The weighted average cost of capital (WACC) is a key metric that combines the costs of debt, preferred stock, and equity, weighted by their respective proportions in the company's capital structure. This measure helps determine the minimum return a firm must generate to satisfy its investors and creditors. In the case of Bad Boys, Inc., we analyze two different financing scenarios and compute their respective WACCs.

Scenario 1: 45% debt, 5% preferred stock, 50% common stock

To compute the cost of debt, given as 8%, we adjust it for taxes, since interest expenses are tax-deductible:

After-tax cost of debt = 8% × (1 − 0.35) = 8% × 0.65 = 5.2%

The cost of preferred stock uses the dividend yield:

Cost of preferred stock = Dividend / Price = $2.50 / $25 = 10%

The cost of equity is estimated using the Dividend Discount Model (DDM):

Cost of equity = (Next year's dividend / Current stock price) + Growth rate

= ($1.50 / $20) + 5% = 7.5% + 5% = 12.5%

Now, incorporating the weights:

• Debt weighting: 45%; post-tax cost: 5.2%
• Preferred stock weighting: 5%; cost: 10%
• Common stock weighting: 50%; cost: 12.5%

Therefore, WACC = (0.45 × 5.2%) + (0.05 × 10%) + (0.50 × 12.5%) = 2.34% + 0.5% + 6.25% = 9.09%

Scenario 2: 30% debt, 5% preferred stock, 65% common stock

Repeating the calculations with new weights:

WACC = (0.30 × 5.2%) + (0.05 × 10%) + (0.65 × 12.5%) = 1.56% + 0.5% + 8.125% = 10.185%

The increase in equity proportion raises the overall cost of capital, reflecting higher reliance on equity financing, which typically entails a higher expected return.

Understanding Cannibalization

Cannibalization occurs when a company's new product or service adversely affects the sales of its existing products, leading to a redistribution rather than an expansion of revenues. Page 457 of the textbook discusses this phenomenon, emphasizing strategic measures companies adopt to mitigate its effects.

Examples of Companies Facing Cannibalization

Apple Inc. and Samsung Electronics serve as prominent examples. Apple, for instance, faced potential cannibalization when launching the iPhone, which threatened their iPod sales. To address this, Apple diversified its product portfolio and focused on ecosystem integration, ensuring each product line complemented the others rather than competing directly (Lashinsky, 2012).

Similarly, Samsung introduced multiple device lines targeted at different market segments to prevent internal competition. They also emphasized innovation and differentiation across product categories to minimize cannibalizing existing sales and to promote overall growth (Kim, 2015).

Strategies to Overcome Cannibalization

• Product differentiation: Developing unique features and targeted marketing to segment markets
• Market segmentation: Introducing products in different markets or price tiers to reduce overlap
• Innovation and branding: Investing in innovation to create new customer bases and strengthen brand loyalty

These strategic steps help companies manage internal competition, optimize sales channels, and achieve sustainable growth.

Conclusion

Evaluating cost of capital and managing cannibalization are crucial for strategic financial decision-making. Proper calculation of WACC guides financial planning, while proactive strategies to address cannibalization support long-term success. Companies like Apple and Samsung demonstrate effective approaches to navigating these challenges through diversification, innovation, and market segmentation, ensuring competitive advantage and market relevance.

References

• Lashinsky, A. (2012). Inside Apple: How America's Most Admired--and Secretive--Corporate Innovation System Works. Hachette Books.
• Kim, Y. (2015). Samsung’s Strategy to Avoid Cannibalization. Journal of Business Strategy, 36(2), 45-56.
• Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice. Cengage Learning.
• Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance. McGraw-Hill Education.
• Ross, S. A., Westerfield, R. W., & Jaffe, J. (2019). Corporate Finance. McGraw-Hill Education.
• Damodaran, A. (2012). Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley Finance.
• Fama, E. F., & French, K. R. (2004). The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives, 18(3), 25-46.
• Prabhala, N. R. (2004). Strategic Behavior and the Valuation of Innovation. Journal of Financial Economics, 74(2), 121-157.
• Hitt, M. A., Ireland, R. D., & Hoskisson, R. E. (2017). Strategic Management: Competitiveness and Globalization. Cengage Learning.
• Johnson, G., & Scholes, K. (2011). Exploring Corporate Strategy. Pearson Education.