Integrated Case Coleman Technologies Inc. 10-22 COST OF CAPITAL Coleman Technologies is considering a major expansion program that has been proposed by the company's information technolo Before proceeding with the expension, the company must estimate its cost of capital Suppose you are sent to Jerry Lemar, the financial vicepresident our first task is to estimate Coleman's cost of capital Lehman has provided you with the following data which he believes may be relevant to your task The firm's tax rate is 10% The current price of Coloma's 12 compon, payment, calable bonde with 15 years remaining to mais $1,153.72. Coleman does not use short-term, interest-bearing detta pembusi New bonds would be privately placed with no flotation.com The current price of the firm's 100 $100.00 par value, quarterly dividend perpetual preferred stockis $111.10 . Coloman's common stock is currently selling for $50.00 per share. Insa dividend (D) 1.1 dividends are expected to grow at constanta rate of in the sale future. Cole's beta 12, the yield an T-bonds is 7% and the market risk pemium is estimated to be 6. For the body plus-is-premium approach, the fires a risk premium of % Coleman's target cupital structure is 30% debt. 10% preferred stock and 60% common equility. To structure the task somewhat lelassend you to the following questions 1. What sources of capital should be included when you stimate Com VCCT 2. Should the component costs be figured on a before-tax or an after tax basist Should the costs be historical (embedded) costs or wall costat b. What is the market interest rate on Coleman's debt and its component cost of dete? 1. What is the firm's cost of preferred stock 2.Coleman's preferred stockis riskier to investors than its debit, yet the preferred's yield to investors is lower than the yield to maturity on the debt. Does this sucrest that you have made a mistake? (Hit Think about two) 1. Why is there a cost associated with retained earnings 2. What is Coleman's estimated cost of common equitysing the CAPM approach? e. What is the estimated cost of common equality using the DCF approach What is the bondeld-plus-rise premium estimate for Colemma's cost of common equity? What is your final estimate for Explain words why new commenck has contraindeaming 1. What are two approaches that can be used to adjust for fotation costs! 2. Coleman estimates that if it is common stock the flotation cost will be 15. Coleman 1. Why is there a cost anciated with retained earnings! 2. What is Coleman's estimated cost of common quality using the CAP approach? e. What is the estimated cost of common equity using the DC approach What is the bodyld-plus-rise-premium estimate for Coleman's cost of common equity? What is your final estate for 1. Explain in words wine common stock has a higher con than reed earnings 1. What are two approaches that can be used to adjust for flotation costs 2. Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common mark, considering the flotations 1. What is Coleman's overall or weighted average cost of capital (WACC) lore flotation costs. k What factors influence Coleman's composite WACC I should the company use the composite WACC as the hardere for each of its projects Explain Integrated Case Coleman Technologies Inc. 10-22 COST OF CAPITAL Coleman 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. Suppose you are an assistant to Jerry Lehman, the financial vice president. Your first task is to estimate Coleman's cost of capital. Lehman has provided you with the following data, which he believes may be relevant to your task. The firm's tax rate is 40%. The current price of Coleman's 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity, is $1,153.72. Coleman does not use short-term, interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firm's 10%, $100.00 par value, quarterly dividend, perpetual preferred stock is $111.10. Coleman's common stock is currently selling for $50.00 per share. Its last dividend (D) was $4.19, and dividends are expected to grow at a constant annual rate of 5% in the foreseeable future. Coleman'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-risk-premium approach, the firm uses a risk premium of 4%. a. C. Coleman's target capital structure is 30% debt, 10% preferred stock, and 60% common equity. To structure the task somewhat, Lehman has asked you to answer the following questions, 1. What sources of capital should be included when you estimate Coleman'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? b. What is the market interest rate on Coleman's debt and its component cost of debt? 1. What is the firm's cost of preferred stock? 2. Coleman'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.) 1. Why is there a cost associated with retained earnings? 2. What is Coleman's estimated cost of common equity using the CAPM approach? e. What is the estimated cost of common equity using the DCF approach? f. What is the bond-yield-plus-risk-premium estimate for Coleman's cost of common equity? g. What is your final estimate for rs ? h. Explain in words why new common stock has a higher cost than retained earnings. d. i. 1. What are two approaches that can be used to adjust for flotation costs? 2. Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman d. 1. Why is there a cost associated with retained earnings? 2. What is Coleman's estimated cost of common equity using the CAPM approach? e. What is the estimated cost of common equity using the DCF approach? f. What is the bond-yield-plus-risk-premium estimate for Coleman's cost of common equity? g. What is your final estimate for rs? h. Explain in words why new common stock has a higher cost than retained earnings. 1. What are two approaches that can be used to adjust for flotation costs? 2. Coleman estimates that if it issues new common stock, the flotation cost will be 15%. Coleman incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost? j. What is Coleman's overall, or weighted average cost of capital (WACC)? Ignore flotation costs. k. What factors influence Coleman's composite WACC? 1. Should the company use the composite WACC as the hurdle rate for each of its projects? Explain
