The Weighted Average Cost Of Capital By The Due Date Assignm

The Weighted Average Cost Of Capitalby The Due Date Assi

Assignment 2: The Weighted Average Cost of Capital By the due date assigned, complete the following assignment: Coogly Company is attempting to identify its weighted average cost of capital for the coming year and has hired you to answer some questions they have about the process. They have asked you to present this information in a PowerPoint presentation to the company’s management team. The company would like for you to keep your presentation to approximately 10 slides and use the notes section in PowerPoint to clarify your point. Your presentation should address the following questions and offer a final recommendation to Coogly. Make sure you support your answers and clearly explain the advantages and disadvantages of utilizing the weighted average cost of capital methodology.

Include at least one graph or chart in your presentation. Company Information The capital structure for the firm will be maintained and is now 10% preferred stock, 30% debt, and 60% new common stock. No retained earnings are available. The marginal tax rate for the firm is 40%. Coogly has outstanding preferred stock That pays a dividend of $4 per share and sells for $82 per share, with a floatation cost of $6 per share.

What is the component cost for Coogly's preferred stock? What are the advantages and disadvantages of using preferred stock in the capital structure? If the company issues new common stock, it will sell for $50 per share with a floatation cost of $9 per share. The last dividend paid was $3.80 and this dividend is expected to grow at a rate of 7% for the foreseeable future. What is the cost of new equity to the firm?

What are the advantages and disadvantages of issuing new equity in the capital structure? The company will use new bonds for any capital project, according to the capital structure. These bonds will have a market and par value of $1000, with a coupon rate of 6% and a floatation cost of 7%. The bonds will mature in 20 years and no other debt will be used for any new investments. What is the cost of new debt?

What are the advantages and disadvantages of issuing new debt in the capital structure? Given the component costs identified above and the capital structure for the firm, what is the weighted average cost of capital for Coogly? What are the advantages and disadvantages of using this method in the capital budgeting process? Submit your assignment to the Submissions Area through the end of the module.

Paper For Above instruction

The comprehensive evaluation of a company’s capital structure through the Weighted Average Cost of Capital (WACC) is a crucial financial metric for making investment and financing decisions. It encapsulates the cost of equity, preferred stock, and debt, weighted by their proportions in the firm's capital structure. This paper explores the calculation of each component's cost for Coogly Company and discusses the advantages and disadvantages associated with each form of financing, culminating in the determination of the company’s overall WACC and its strategic implications.

Cost of Preferred Stock

The preferred stock's component cost is calculated by dividing the dividend per share by the net issuing price per share, which accounts for flotation costs. Coogly's preferred stock pays a dividend of $4 per share, with a current selling price of $82 and flotation costs of $6 per share. The net proceeds from issuing preferred stock are thus $76 ($82 - $6). Therefore, the preferred stock cost (Kp) is:

 

Kp = Dividend / Net proceeds = $4 / $76 ≈ 5.26%

Advantages of preferred stock include its fixed dividend payments and priority over common equity in dividend distribution and liquidation. It can also improve a company's creditworthiness by providing a tiered capital structure. However, disadvantages include its higher cost relative to debt, potential dilution of earnings, and the fact that dividends are not tax-deductible, unlike interest payments.

Cost of New Equity

When issuing new common stock, the cost is often estimated using the Dividend Discount Model (DDM), considering dividends, growth rate, and flotation costs. The last dividend (D0) was $3.80, expected to grow annually at 7%, and the stock price is $50 with flotation costs of $9 per share. The dividend one year from now (D1) is:

D1 = D0 × (1 + g) = $3.80 × 1.07 ≈ $4.07

The cost of equity (Ke) before flotation costs is:

Ke = (D1 / Pnet) + g

where Pnet is the net proceeds after flotation costs:

Pnet = $50 - $9 = $41

Thus,

Ke = ($4.07 / $41) + 0.07 ≈ 0.0994 + 0.07 ≈ 16.94%

Advantages of issuing new equity include raising capital without incurring debt, thus avoiding fixed financial obligations and interest payments. It can also improve leverage and credit metrics. Disadvantages include dilution of existing shareholders’ ownership, higher flotation costs, and a potentially higher overall cost of capital compared to debt.

Cost of New Debt

Coogly plans to issue bonds with a face value of $1000, a coupon rate of 6%, and flotation costs of 7%. The bonds have a maturity of 20 years. The before-tax cost of debt (Kd) is equal to the bond's yield to maturity (YTM), which in this case can be approximated by adjusting the coupon rate for flotation costs:

Effective coupon payment = 6% of face value = $60


Net proceeds per bond = $1000 - 7% of $1000 = $930

Using the approximation formula:

Kd = [Coupon Payment / Net proceeds] + [(Face Value - Net proceeds) / Years to Maturity]

Alternatively, a precise calculation via YTM formulas yields approximately 6.5%. Adjusted for taxes:

After-tax cost of debt = Kd × (1 - Tax rate) = 6.5% × (1 - 0.40) ≈ 3.9%

Advantages of debt financing include tax deductibility of interest, lower relative costs compared to equity, and no dilution of ownership. Disadvantages involve increased financial risk, potential for insolvency, and fixed debt obligations regardless of company performance.

Calculating the WACC

The weightings are based on Coogly’s capital structure: 10% preferred stock, 30% debt, and 60% equity (comprising both existing and new). Using the component costs:

  • Preferred stock: 5.26%
  • Debt: 3.9% (after tax)
  • Equity: 16.94%
WACC = (wd × Kd) + (wp × Kp) + (we × Ke)


Where:


wd = 0.30, wp = 0.10, we = 0.60

Thus,

WACC = (0.30 × 3.9%) + (0.10 × 5.26%) + (0.60 × 16.94%) ≈ 1.17% + 0.53% + 10.16% ≈ 11.86%

This WACC represents the average rate that Coogly must earn on its investments to satisfy its capital providers.

Advantages and Disadvantages of Using WACC

The WACC is a vital tool in capital budgeting because it provides a benchmark for evaluating investment projects. Projects with expected returns above the WACC are generally considered worthwhile. Its advantages include simplicity, integration of the cost of various financing sources, and consistency in evaluation criteria. However, it also has disadvantages. WACC assumptions may oversimplify complex capital structures, and it may not be suitable for projects with different risk profiles than the firm’s average. Additionally, it relies heavily on accurate estimates of component costs, which can be challenging to determine precisely.

Conclusion

In conclusion, calculating and utilizing the WACC enables Coogly to make informed decisions regarding capital investments and financing strategies. It balances the costs associated with different sources of capital and aligns investment appraisals with the company’s overall risk profile and strategic objectives. While it offers significant advantages by streamlining investment evaluations, practitioners must be aware of its limitations and ensure rigorous estimation of component costs to maximize its effectiveness.

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