The Weighted Average Cost Of Capital For Coogly Company Is A
The Weighted Average Cost Of Capitalcoogly Company Is Attempting To Id
The Weighted Average Cost of Capitalcoogly 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 M4: Assignment 2 Dropbox.
Paper For Above instruction
Introduction
Understanding the weighted average cost of capital (WACC) is crucial for firms like Coogly in making informed investment decisions and structuring their capital reliably. This paper calculates the components of the company's capital costs—preferred stock, equity, and debt—and then determines the overall WACC. It also discusses the benefits and drawbacks of using each financing source, as well as the advantages and disadvantages of WACC in capital budgeting.
Component Cost of Preferred Stock
Preferred stock typically provides a fixed dividend, making its cost calculation straightforward. The component cost of preferred stock (Kp) is calculated as follows:
\[
Kp = \frac{D_{ps}}{P_{net}}
\]
where \( D_{ps} \) is the dividend per preferred share, and \( P_{net} \) is the net issuing price, accounting for floatation costs.
Given:
- Dividend \( D_{ps} = 4 \)
- Market price \( P = 82 \)
- Floatation cost per share = 6
Net issuing price:
\[
P_{net} = P - \text{floatation cost} = 82 - 6 = 76
\]
Therefore:
\[
Kp = \frac{4}{76} \approx 5.26\%
\]
Advantages and Disadvantages of Preferred Stock
Preferred stock offers a stable dividend and ranks ahead of common equity in dividend payments, providing a less risky income stream. However, it can be costly compared to debt, does not offer tax deductibility, and may dilute control if new issues are made.
Cost of Equity: New Common Stock
The cost of new common equity (Ke) can be estimated using the Dividend Discount Model (DDM), adjusted for flotation costs:
\[
Ke = \frac{D_1}{P_{net}} + g
\]
where:
- \( D_1 \) = Next year's dividend = last dividend \( D_0 \) grown by \( g \)
- \( P_{net} \) = Issue price minus flotation costs
Calculations:
\[
D_1 = 3.80 \times (1 + 0.07) = 4.07
\]
Net price:
\[
P_{net} = 50 - 9 = 41
\]
Thus:
\[
Ke = \frac{4.07}{41} + 0.07 \approx 0.099 + 0.07 = 16.9\%
\]
Advantages and Disadvantages of Issuing New Equity
Equity financing avoids debt obligations and interest payments, and does not increase financial leverage risk. However, it can dilute existing ownership, is often more expensive than debt, and may signal financial weakness when issued in large amounts.
Cost of New Debt
The cost of new debt (Kd) accounts for floatation costs and the tax shield:
\[
K_{d} = \frac{Coupon}{Net\ proceeds}
\]
Net proceeds:
\[
\$1000 \times (1 - 0.07) = 930
\]
Coupon payment:
\[
\$1000 \times 6\% = \$60
\]
Therefore:
\[
K_d = \frac{60}{930} \approx 6.45\%
\]
Since interest expense is tax-deductible, the after-tax cost:
\[
K_{d\_after} = K_d \times (1 - T) = 6.45\% \times (1 - 0.40) = 3.87\%
\]
Advantages and Disadvantages of Issuing New Debt
Debt is typically less costly due to tax benefits and fixed interest payments, providing leverage benefits. However, excessive debt increases bankruptcy risk and reduces financial flexibility, especially if market conditions deteriorate.
Calculating the WACC
The firm maintains a target capital structure of:
- 10% preferred stock
- 30% debt
- 60% new common stock
Using the previous component costs:
\[
WACC = (W_{ps} \times K_{p}) + (W_{d} \times K_{d\_after}) + (W_{ce} \times K_{e})
\]
Substituting:
\[
WACC = 0.10 \times 5.26\% + 0.30 \times 3.87\% + 0.60 \times 16.9\%
\]
\[
WACC = 0.526\% + 1.161\% + 10.14\% = 11.83\%
\]
Advantages and Disadvantages of WACC in Capital Budgeting
WACC provides a comprehensive measure of the firm's average cost of capital, facilitating investment decisions. However, it assumes capital structure stability and ignores project-specific risks, potentially leading to distorted valuations.
Conclusion
The calculated WACC for Coogly is approximately 11.83%, reflecting the costs associated with preferred stock, equity, and debt within its capital structure. By leveraging this metric, management can evaluate potential investments and optimize capital structure. While the WACC approach offers a robust and straightforward method for assessing project feasibility, it also has limitations, notably its assumption of constant capital costs and structure over time, which may not reflect market dynamics or project-specific risks. In sum, WACC remains a vital tool for strategic decision-making, provided its limitations are understood and contextualized.
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