The Manager Of Sensible Essentials Conducted An Excellent Sa

The Manager Of Sensible Essentials Conducted An Excellent Seminar Expl

The manager of Sensible Essentials conducted an excellent seminar explaining debt and equity financing and how firms should analyze their cost of capital. Nevertheless, the guidelines failed to fully demonstrate the essence of the cost of debt and equity, which is the required rate of return expected by suppliers of funds. You are the Genesis accountant and have taken a class recently in financing. You agree to prepare a PowerPoint presentation of approximately 6–8 minutes using the examples and information below: Debt: Jones Industries borrows $600,000 for 10 years with an annual payment of $100,000. What is the expected interest rate (cost of debt)? Internal common stock: Jones Industries has a beta of 1.39. The risk-free rate as measured by the rate on short-term US Treasury bill is 3 percent, and the expected return on the overall market is 12 percent. Determine the expected rate of return on Jones’s stock (cost of equity). Here are the details: Jones Total Assets $2,000,000 Long- & short-term debt $600,000 Common internal stock equity $400,000 New common stock equity $1,000,000 Total liabilities & equity $2,000,000 Develop a 10–12-slide presentation in PowerPoint format. Perform your calculations in an Excel spreadsheet. Cut and paste the calculation into your presentation. Include speaker’s notes to explain each point in detail. Apply APA standards to citation of sources. By Wednesday, December 4, 2013 , deliver your assignment to the M4: Assignment 2 Assignment 2 Grading Criteria Calculated the expected interest rate (cost of debt). Calculated the expected rate of return on Jones’s stock (cost of equity). Wrote in a clear, concise, and organized manner; demonstrated ethical scholarship in accurate representation and attribution of sources; displayed accurate spelling, grammar, and punctuation.

Paper For Above instruction

Sensible Essentials Seminar: Cost of Capital Analysis

The seminar led by the manager of Sensible Essentials provided an insightful overview of two fundamental sources of financing for firms: debt and equity. It highlighted how assessing the cost of capital—comprising the cost of debt and the cost of equity—is crucial for making informed financial decisions. However, the explanation did not fully elucidate the core concept that the cost of debt and equity represents the required rate of return expected by the providers of these funds. In this context, "cost" is the minimum return investors or lenders require to compensate for the risk they undertake.

This analysis will focus on calculating these critical components for Jones Industries based on provided data. First, we will determine the expected cost of debt using an amortized loan calculation methodology. Then, we will compute the required rate of return on the company's stock via the Capital Asset Pricing Model (CAPM). These calculations exemplify how firms quantify their cost of capital to guide investment and financing decisions.

Calculating the Cost of Debt

Jones Industries has borrowed $600,000 over a 10-year period, with annual payments of $100,000. To find the effective interest rate or the cost of debt, we treat this as an amortized loan and solve for the interest rate that equates the present value of all payments to the loan amount. Using the Excel RATE function, we input the number of periods (10), payment amount ($100,000), and present value (-$600,000).

Formula in Excel: =RATE(10, -100000, 600000)

This calculation yields an approximate annual interest rate of 8.85%. This rate reflects the firm's cost of debt, considering the agreed-upon repayment schedule and interest terms.

Calculating the Cost of Equity

The cost of equity is estimated through the Capital Asset Pricing Model (CAPM), which states:

Expected Return (Re) = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate)

Given data: risk-free rate = 3%, beta = 1.39, market return = 12%

Re = 3% + 1.39 × (12% - 3%) = 3% + 1.39 × 9% = 3% + 12.51% = 15.51%

This implies that investors expect a 15.51% return for investing in Jones Industries' equity, aligning with their risk profile indicated by the beta coefficient.

Company Financial Overview and Weighted Average Cost of Capital (WACC)

Jones Industries' total assets are valued at $2,000,000, with $600,000 in debt and $1,400,000 in equity (both common internal stock and new stock). The composition influences the firm's overall cost of capital. Calculating the weights:

• Debt weight: $600,000 / $2,000,000 = 30%
• Equity weight: ($400,000 + $1,000,000) / $2,000,000 = 70%

Assuming the effective cost of debt is 8.85%, and the cost of equity is 15.51%, the WACC is computed as:

WACC = (0.30 × 8.85%) + (0.70 × 15.51%) = 2.655% + 10.857% = 13.512%

This weighted average provides the minimum return that the firm must earn to satisfy its debt holders and shareholders.

Conclusion

Understanding and accurately calculating the cost of debt and equity are vital for firms like Jones Industries to evaluate their investment opportunities and maintain stakeholder confidence. The calculated cost of debt (8.85%) reflects the return creditors expect given the loan parameters. The cost of equity (15.51%) captures the shareholders' required return based on market risk factors. Combining these in the WACC enables the firm to make informed financial decisions aligned with its strategic objectives.

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