Please Do Questions E-L!

A) 1) The sources of capital which should be included in Coleman's WACC are noncallable bond, preferred stock and common stock. 2) The components cost should be figured on after tax basis before the costs of the component may be tax deductible, which would decrease the cost of the component. 3) The costs should be new (marginal) cost rather than historical cost because the new (marginal) costs takes into consideration the present scenario and gives a much more real and accurate picture than historical cost. B) Using financial calculator to calculate the cost of bond Inputs: N= 15 x 2 = 30 (semiannual compounding) Pv= -1,153.72 Pmt= 12% / 2 x 1,000 = 60 Ev= 1,000 1/y= compute We get, ytm of the bond as 5% x 2 = 10% Market interest rate of Coleman's debt= 10% After tax cost of debt (cost of component)= 10% (1-tax rate) = 10% (1-0.40) = 10% (0.6) = 6% q1) cost of preference share = dividend/ current price = 10% x 100 / 111.10 = 10 / 111.10 = 9% 2) No, I have not made a mistake. The Coleman's debt has higher yield than preference share because interest paid on debt is before tax and it has not been adjusted for. Where as dividends are paid after tax, so the cost of preference share is lesser than that of yield on debt. Once the tax is deducted from ytm of bond, the cost of bond becomes lesser than that of preference share. D) 1) There is a cost associated with retained earnings because these earnings have been retained by the company for future investment in other opportunities, which might provide lower return than what the shareholders could have generated if distributed to them. 2) Using CAPM model Expected return= risk free rate + beta (market risk premium) = 7% + 1.2 (69) = 7% + 7.2% = 14.2% E) Using DCF model Cost of equity = dividend (1+growth rate) / price + growth rate = 4.19 (1+ 0.05) / 50 + 0.05 = 4.19 (1.05) / 50 + 0.05 = 4.3995 / 50 + 0.05 = 0.0880 + 0.05 = 0.1380 or 13.80% F) Using Bond yield plus risk premium Cost of equity = ytm of long term bond + risk premium = 10% + 4% = 14% . . COST OF CAPITAL Coleman Technologies is considering a major expansion program that has been proposed by the company's information technology proup. Before proceeding with the expansion, the company must estimate its cost of apital. Suppose you are an assistant to Jerry Lehman, the financial vicepresident. Your first task is to estimate Coleman's cost of capital. Lehman has provided you with the following data, which he believes may berelevant 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 ona 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 (Do) was $4.19, and dividends are expected to growata constant annual rate of 5% in the foreseeable future. Coleman's beta is 1.2, the yield on T-bondsis 7%, and the market risk premium is estimated to be 5%. For the bond- yield-plus-risk-premium approach, the firm uses a risk premium of 4%. 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 befigured on a before tax or an after-tax basis? 3. Should the costs behistorical (embedded) costs or new (marginal) costs? b. What is the market interest rate on Coleman's debtand 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 investorsis 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 costassociated with retained earnings? 2. What is Coleman's estimated cost of common equity using the CAPMapproach? 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? E. What is your final estimate forr, 7 C. d. i 1. Explain in words why new common stock has a higher cost than retained earnings, 1. What are two approaches that can beused to adjust for flotation costs? 2. Coleman estimates that ifitissues 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? 1. What is Coleman's overall, or weighted average cost of capital (WACC)? Iporeflotation costs. k. What factors influence Coleman's composite WACC? 1. Should the company use the composite WACC as the hurdlerate for each of its projects? Explain. A) 1) The sources of capital which should be included in Coleman's WACC are noncallable bond, preferred stock and common stock. 2) The components cost should be figured on after tax basis before the costs of the component may be tax deductible, which would decrease the cost of the component. 3) The costs should be new (marginal) cost rather than historical cost because the new (marginal) costs takes into consideration the present scenario and gives a much more real and accurate picture than historical cost. B) Using financial calculator to calculate the cost of bond Inputs: N= 15 x 2 = 30 (semiannual compounding) Pv= -1,153.72 Pmt= 12% / 2 x 1,000 = 60 Ev= 1,000 1/y= compute We get, ytm of the bond as 5% x 2 = 10% Market interest rate of Coleman's debt= 10% After tax cost of debt (cost of component)= 10% (1-tax rate) = 10% (1-0.40) = 10% (0.6) = 6% q1) cost of preference share = dividend/ current price = 10% x 100 / 111.10 = 10 / 111.10 = 9% 2) No, I have not made a mistake. The Coleman's debt has higher yield than preference share because interest paid on debt is before tax and it has not been adjusted for. Where as dividends are paid after tax, so the cost of preference share is lesser than that of yield on debt. Once the tax is deducted from ytm of bond, the cost of bond becomes lesser than that of preference share. D) 1) There is a cost associated with retained earnings because these earnings have been retained by the company for future investment in other opportunities, which might provide lower return than what the shareholders could have generated if distributed to them. 2) Using CAPM model Expected return= risk free rate + beta (market risk premium) = 7% + 1.2 (69) = 7% + 7.2% = 14.2% E) Using DCF model Cost of equity = dividend (1+growth rate) / price + growth rate = 4.19 (1+ 0.05) / 50 + 0.05 = 4.19 (1.05) / 50 + 0.05 = 4.3995 / 50 + 0.05 = 0.0880 + 0.05 = 0.1380 or 13.80% F) Using Bond yield plus risk premium Cost of equity = ytm of long term bond + risk premium = 10% + 4% = 14% . . COST OF CAPITAL Coleman Technologies is considering a major expansion program that has been proposed by the company's information technology proup. Before proceeding with the expansion, the company must estimate its cost of apital. Suppose you are an assistant to Jerry Lehman, the financial vicepresident. Your first task is to estimate Coleman's cost of capital. Lehman has provided you with the following data, which he believes may berelevant 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 ona 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 (Do) was $4.19, and dividends are expected to growata constant annual rate of 5% in the foreseeable future. Coleman's beta is 1.2, the yield on T-bondsis 7%, and the market risk premium is estimated to be 5%. For the bond- yield-plus-risk-premium approach, the firm uses a risk premium of 4%. 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 befigured on a before tax or an after-tax basis? 3. Should the costs behistorical (embedded) costs or new (marginal) costs? b. What is the market interest rate on Coleman's debtand 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 investorsis 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 costassociated with retained earnings? 2. What is Coleman's estimated cost of common equity using the CAPMapproach? 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? E. What is your final estimate forr, 7 C. d. i 1. Explain in words why new common stock has a higher cost than retained earnings, 1. What are two approaches that can beused to adjust for flotation costs? 2. Coleman estimates that ifitissues 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? 1. What is Coleman's overall, or weighted average cost of capital (WACC)? Iporeflotation costs. k. What factors influence Coleman's composite WACC? 1. Should the company use the composite WACC as the hurdlerate for each of its projects? Explain