Case - 14.1. The Lazquez Company

Suppose you are the assistant to the CFO of the Lazquez Company and are responsible for evaluating how its cost of capital is calculated. The Lazquez Company has the following financial structure:

Accounts payable$1.0

Wages payable$0.5

Bank loans$2.0

Long-term bonds$10.0

Pension liability$3.5

Minority interest$2.0

Common stock (1.5 million shares outstanding) $1.5

Retained earnings$10.0

Accumulated comprehensive income or loss$1.5

Treasury stock$1

Additional information:

The market price per share of stock is $20.

The outstanding bonds have a coupon rate of 6 percent and mature in 10 years.

The outstanding bonds are currently priced at 110.

The beta of its common stock is 1.2.

The expected risk-free rate of interest is 3 percent.

The expected market risk premium is 4.5 percent.

The marginal tax rate is 35 percent.

The Lazquez Company currently uses 10 percent as its cost of capital and has been doing so for the past 10 years.

A. an analysis of the cost of capital for the Lazquez Company, detailing your calculations of the weights and the costs of the different sources of capital. Be sure to note your assumptions and address the sensitivity of your recommendation to the various inputs.

B. Based on your estimate, what are the implications of the Lazquez Company continuing to use a 10 percent cost of capital?

C. If Congress lowers the tax rates for corporations, what is the effect on the Lazquez Company's cost of capital? Demonstrate this using your spreadsheet analysis.