Question
1) ( Divisional costs of capital ) LPT Inc. is an integrated oil company headquartered inDallas, Texas. The company has three operatingdivisions: oil exploration and
1) (Divisional costs of capital) LPT Inc. is an integrated oil company headquartered inDallas, Texas. The company has three operatingdivisions: oil exploration and production(commonly referred to asE&P), pipelines, and refining.Historically, LPT did not spend a great deal of time thinking about the opportunity costs of capital for each of its divisions and used acompany-wide weighted average cost of capital of 14 percent for all new capital investment projects. Recent changes in its businesses have made it abundantly clear toLPT's management that this is not a reasonable approach. Forexample, investors demand a much higher expected rate of return for exploration and production ventures than for pipeline investments. AlthoughLPT's managementagrees, in principle atleast, that different operating divisions should face an opportunity cost of capital that reflects their individual riskcharacteristics, they are not in agreement about whether a move toward divisional costs of capital is a good idea based on practical considerations.
a. Pete Jennings is the chief operating officer for theE&P division, and he is concerned that going to a system of divisional costs of capital may restrain his ability to undertake very promising exploration opportunities. He argues that the firm really should be concerned about finding those opportunities that offer the highest possible rate of return on invested capital. Pete contends that using thefirm's scarce capital to take on the most promising projects would lead to the greatest increase in shareholder value. Do you agree withPete? Why or whynot?
b. The pipeline divisionmanager, DonnaSelma, has long argued that charging her division thecompany-wide cost of capital of 14 percent severely penalizes her opportunities to increase shareholder value. Do you agree withDonna? Explain.
Pete's division invests capital inhigh-risk projects and should use an appropriaterisk-based
divisional or company-wide cost of capital.Donna's division involveslow-risk activities and her division should use its ownrisk-based divisional or company-wide
cost of capital. Each division should use the cost of capital that reflects the risk level of the division or company
out of the underline bold which one is the correct answer and why
2) (Weighted average cost of capital) The capital structure for the Carion Corporation is providedhere: The company plans to maintain its debt structure in the future. If the firm has anafter-tax cost of debt of 6.4 percent, a cost of preferred stock of 10.6 percent, and a cost of common stock of 17.4 percent, what is thefirm's weighted average cost ofcapital?
Bonds 1,135
Preferred stock 267
Common stock 3,592
4,994
Thefirm's weighted average cost of capital is _______%. (Round to two decimalplaces.)
3) (Cost of debt) The Zephyr Corporation is contemplating a new investment to be financed 33 percent from debt. The firm could sell new $ 1,000 par value bonds at a net price of $930 The coupon interest rate is 8 percent, and the bonds would mature in 15 years. If the company is in a 35 percent taxbracket, what is theafter-tax cost of capital to Zephyr forbonds?
Theafter-tax cost of capital to Zephyr for bonds is ____%. (Round to two decimalplaces.)
4) (Individual or component costs of capital) Compute the costs for the following sources offinancing:
a. A $ $1,000 par value bond with a market price of $ 975 and a coupon interest rate of 11 percent. Flotation costs for a new issue would be approximately 7 percent. The bonds mature in 15 years and the corporate tax rate is 36 percent.
b. A preferred stock selling for $ 119 with an annual dividend payment of $ 11 The flotation cost will be $ 9 per share. Thecompany's marginal tax rate is 30 percent.
c. Retained earnings totaling $ 4.8 million. The price of the common stock is $ 71 pershare, and dividend per share was $ 8.21 ast year. The dividend is not expected to change in the future.
d. New common stock for which the most recent dividend was $ 2.88 Thecompany's dividends per share should continue to increase at a growth rate of 8 percent into the indefinite future. The market price of the stock is currently $ 59 however, flotation costs of $ 7 per share are expected if the new stock is issued.
a. What is thefirm's after-tax cost of debt on thebond? ___% (Round to two decimalplaces.)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started