4) a. Yorkman Technologies is considering a major expansion program that has been proposed by the company's information technology group. Before proceeding with the expansion, the company must estimate its cost of capital. Assume that you are an assistant to Troy Alkman, the financial vice president. Your first task is to estimate Yorkman's cost of capital. Aikman has provided you with the following data, which he believes may be relevant to your task. (1) The firm's tax rate is 40% (2) The current price of Yorkman's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Yorkman does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. (3) The current price of the firm's 10%, $100.00 par value, quarterly dividend, perpetual preferred stock is $111.10. (4) Yorkman's common stock is currently selling for $50.00 per share. Its last dividend (DO) was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Yorkman's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-riskpremium approach, the firm uses a risk premium of 4%. (5) Yorkman's target capital structure is 30% debt, 10% preferred stock, and 60% common equity. To structure the task somewhat, Alkman has asked you to answer the following questions (1) What sources of capital should be included when you estimate Yorkman's WACC? (2) Should the component costs be figured on a before-tax or an after-tax basis? (3) Should the costs be historical (embedded) costs or new (marginal) costs? What is the market interest rate on Yorkman's debt and its component cost of debt? (1) What is the firm's cost of preferred stock? (2) Yorkman's preferred stock is riskier to investors than its debt, yet the preferred's yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Hint: Think about taxes.) d. (1) Why is there a cost associated with retained earnings? (2) What is Yorkman's estimated cost of common equity using the CAPM approach? What is the estimated cost of common equity using the DCF approach? What is the bond-yield-plus-risk-premium estimate for Yorkman's cost of common equity? What is your final estimate for rs? h. Explain in words why new common stock has a higher cost than retained earnings. 1. (1) What are two approaches that can be used to adjust for flotation costs? (2) Yorkman estimates that if it issues new common stock, the flotation cost will be 15% Yorkman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost? 1. What is Yorkman's overall, or weighted average cost of capital (WACC)? ignore flotation costs. What factors influence Yorkman's composite WACC? Should the company use the composite WACC as the hurdle rate for each of its projects? Explain b. C. e. f. g k. I. 4) a. Yorkman Technologies is considering a major expansion program that has been proposed by the company's information technology group. Before proceeding with the expansion, the company must estimate its cost of capital. Assume that you are an assistant to Troy Alkman, the financial vice president. Your first task is to estimate Yorkman's cost of capital. Aikman has provided you with the following data, which he believes may be relevant to your task. (1) The firm's tax rate is 40% (2) The current price of Yorkman's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,153.72. Yorkman does not use short-term interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. (3) The current price of the firm's 10%, $100.00 par value, quarterly dividend, perpetual preferred stock is $111.10. (4) Yorkman's common stock is currently selling for $50.00 per share. Its last dividend (DO) was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Yorkman's beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-riskpremium approach, the firm uses a risk premium of 4%. (5) Yorkman's target capital structure is 30% debt, 10% preferred stock, and 60% common equity. To structure the task somewhat, Alkman has asked you to answer the following questions (1) What sources of capital should be included when you estimate Yorkman's WACC? (2) Should the component costs be figured on a before-tax or an after-tax basis? (3) Should the costs be historical (embedded) costs or new (marginal) costs? What is the market interest rate on Yorkman's debt and its component cost of debt? (1) What is the firm's cost of preferred stock? (2) Yorkman's preferred stock is riskier to investors than its debt, yet the preferred's yield to investors is lower than the yield to maturity on the debt. Does this suggest that you have made a mistake? (Hint: Think about taxes.) d. (1) Why is there a cost associated with retained earnings? (2) What is Yorkman's estimated cost of common equity using the CAPM approach? What is the estimated cost of common equity using the DCF approach? What is the bond-yield-plus-risk-premium estimate for Yorkman's cost of common equity? What is your final estimate for rs? h. Explain in words why new common stock has a higher cost than retained earnings. 1. (1) What are two approaches that can be used to adjust for flotation costs? (2) Yorkman estimates that if it issues new common stock, the flotation cost will be 15% Yorkman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost? 1. What is Yorkman's overall, or weighted average cost of capital (WACC)? ignore flotation costs. What factors influence Yorkman's composite WACC? Should the company use the composite WACC as the hurdle rate for each of its projects? Explain b. C. e. f. g k
