Scanlon Inc.'s CFO Hired You As A Consultant To Help Her Est

Question

Scanlon Incs Cfo Hired You As A Consultant To Help Her Estimate The Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: r RF = 4.10%; RP M = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of equity from retained earnings? You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.75%. The firm will not be issuing any new stock. What is its WACC?

Dr. Jack HW Helper · Accepted Answer

Introduction The estimation of a company's cost of capital is a critical component in financial decision-making, guiding investment evaluations, capital budgeting, and strategic planning. This paper aims to determine the cost of equity for Scanlon Inc. using the Capital Asset Pricing Model (CAPM) and to calculate Giambono Company's weighted average cost of capital (WACC) based on its target capital structure. Both calculations are essential for assessing the company's financing costs and optimizing its capital structure. Cost of Equity Using the CAPM Approach The CAPM formula calculates the expected return on equity as follows: $$ \text{Cost of Equity} = R_f + \beta (R_m - R_f) $$ where: - $ R_f $ is the risk-free rate - $ R_m $ is the expected market return - $ \beta $ measures the sensitivity of the stock's returns to the market Given: - $ R_f = 4.10\% $ - $ R_m = R_P M = 5.25\% $ - $ \beta = 1.30 $ Calculating the market risk premium: $$ R_m - R_f = 5.25\% - 4.10\% = 1.15\% $$ Applying the CAPM formula: $$ \text{Cost of Equity} = 4.10\% + 1.30 \times 1.15\% = 4.10\% + 1.495\% = 5.595\% $$ Therefore, the cost of equity from retained earnings for Scanlon Inc. is approximately 5.60%. Calculating the WACC for Giambono Company The weighted average cost of capital (WACC) represents the average rate that a company is expected to pay to finance its assets, proportional to the target capital structure. It accounts for the cost of debt, preferred stock, and equity. The formula is: $$ \text{WACC} = (w_d \times r_d) + (w_{ps} \times r_{ps}) + (w_e \times r_e) $$ Where: - $ w_d $, $ w_{ps} $, and $ w_e $ are the weights of debt, preferred stock, and equity - $ r_d $, $ r_{ps} $, and $ r_e $ are their respective costs Given: - $ w_d = 40\% $ - $ w_{ps} = 15\% $ - $ w_e = 45\% $ - $ r_d = 6.00\% $ (after-tax) - $ r_{ps} = 7.50\% $ - $ r_e = 12.75\% $ Calculating WACC: \[ \text{WACC} = (0.40 \times 6.00\%) + (0.15 \times 7.50\%) + (0.45 \times

Scanlon Inc.'s CFO Hired You As A Consultant To Help Her Est

Scanlon Incs Cfo Hired You As A Consultant To Help Her Estimate The

Paper For Above instruction

Introduction

Cost of Equity Using the CAPM Approach

Calculating the WACC for Giambono Company

Conclusion

References