Question 2: WACC Estimation (the questions was referenced and revised from Financial Management textbook of Nelson Publishing) The balance sheet for Aurora Equipment Implements Inc provided below along with other selected financial data. Balance Sheet as at December 31, 2020 (5 millions) Cash $10 Accounts payable $10 Accounts Receivable 20 Accruals 10 Inventory 20 Short term debt 5 Total current assets 50 Total current liabilities 25 Long-term debt 20 3 Plant and equipment (net) 38 Preferred stock Common equity 10 Retained earnings 30 Total Assets 588 Total liabilities and equity 588 The facts given: 1. Short term debt consists of bank loans that currently cost 1096 with interest payable quarterly. These loans are used to finance receivables and inventories in a seasonal basis so in the off-season, bank loans are zero 2 The long term debts consist of 20-years semi-annual payment mortgage bond with a coupon rate of 896. Currently these bonds provide a yield to investors of ra = 79. Of new bonds were sold they would yield investors 296 Dond with a coupon investors of rd=7%. Of new bonds were sold, they would yield investors 7%. 3. The firms perpetual preferred stock has a $25 par value, pays a quaterly dividend of $0.45. and has a yield to investors of 6.5%. New perpetual preferred would have to provide the dame yield to investors and the company would incur a 5% flotation cost to sell them. 4. The company has 4 million shares of common stock outstanding. POES20, but the stock has recently traded in the range od 517 to $23. DO =$1 and EPSO=$2. ROE based om average equity was 24% in 2015, but management expects to increase this return on equity to 30%; however security analysists are nor aware of management's optimism in this regards. 5. Betas, as reported by security analyst range from 1.7 to 1.7: the government bond rate is 5%. Brokerage house reports forecast growth rate in the range of 4% to 8% over the forecastable future. However, some analysis does not explicitly forecast growth rates, but they indicate to their clients that they expect Aurora's historical trends. As shown in the table in fact (9) to continue. 6. At a recent conferences. Aurora's financial vice president polled some pension fund investment managers on the minimum rate of return they would have to expect pm Aurora's common to make them willing to buy the common rather than Aurora bonds when the bonds yield 79: The responses suggested a risk premium over Aurora bonds of 3 to 5 percentage points 7 Aurora in in the 30% tax bracket. 8. Aurora principal investment banker. Det company predicts a decline in interest rats with rd falling to 6% and the government bondirate to 4% although 180 acknowledge that an increase in the expected inflation rare could lead to an increase rather than a decrease in cates 9. Here is the historical record of EPS and DPS. Year EPS DPS Year EPS DPS 2006 S0.09 50.00 2014 S0.78 $0.00 2007 -0.2 0.00: 2013 0.80 0.00 3 Fate to 470 although J&J acknowledge that an increase in the expected inflation rare could lead to an increase rather than a decrease in rates. 9. Here is the historical record of EPS and DPS. Year EPS DPS Year EPS DPS 2006 $0.09 $0.00 2014 $0.78 $0.00 2007 -0.2 0.00 2015 0.80 0.00 2008 0.40 0.00 2016 1.20 0.20 2009 0.52 0.00 2017 0.95 0.40 2010 0.10 0.00 2018 1.30 0.60 2011 0.57 0.00 2019 1.60 0.80 2012 0.61 0.00 2020 2.00 1.00 2013 0.70 0.00 Assume that you are a recently hired financial analysist and that your boss, the treasurer, has asked you to estimate the company's WACC. Assume no new equity will be issues. Your cost of capital should be appropriate for use in evaluating projects that are in the same risk class as the firm's average assets now on the books, Write a report including the overall WACC calculation (Amarks) the rational of WACC different (2 marks), approaches in estimating equity costs different @marks), the common mistakes people make when estimating Wadd the pros and cons (2 marks), and give your comments on Aurora's capital structure(2 marks) The data source and reference must be in APA format, Question 2: WACC Estimation (the questions was referenced and revised from Financial Management textbook of Nelson Publishing) The balance sheet for Aurora Equipment Implements Inc provided below along with other selected financial data. Balance Sheet as at December 31, 2020 (5 millions) Cash $10 Accounts payable $10 Accounts Receivable 20 Accruals 10 Inventory 20 Short term debt 5 Total current assets 50 Total current liabilities 25 Long-term debt 20 3 Plant and equipment (net) 38 Preferred stock Common equity 10 Retained earnings 30 Total Assets 588 Total liabilities and equity 588 The facts given: 1. Short term debt consists of bank loans that currently cost 1096 with interest payable quarterly. These loans are used to finance receivables and inventories in a seasonal basis so in the off-season, bank loans are zero 2 The long term debts consist of 20-years semi-annual payment mortgage bond with a coupon rate of 896. Currently these bonds provide a yield to investors of ra = 79. Of new bonds were sold they would yield investors 296 Dond with a coupon investors of rd=7%. Of new bonds were sold, they would yield investors 7%. 3. The firms perpetual preferred stock has a $25 par value, pays a quaterly dividend of $0.45. and has a yield to investors of 6.5%. New perpetual preferred would have to provide the dame yield to investors and the company would incur a 5% flotation cost to sell them. 4. The company has 4 million shares of common stock outstanding. POES20, but the stock has recently traded in the range od 517 to $23. DO =$1 and EPSO=$2. ROE based om average equity was 24% in 2015, but management expects to increase this return on equity to 30%; however security analysists are nor aware of management's optimism in this regards. 5. Betas, as reported by security analyst range from 1.7 to 1.7: the government bond rate is 5%. Brokerage house reports forecast growth rate in the range of 4% to 8% over the forecastable future. However, some analysis does not explicitly forecast growth rates, but they indicate to their clients that they expect Aurora's historical trends. As shown in the table in fact (9) to continue. 6. At a recent conferences. Aurora's financial vice president polled some pension fund investment managers on the minimum rate of return they would have to expect pm Aurora's common to make them willing to buy the common rather than Aurora bonds when the bonds yield 79: The responses suggested a risk premium over Aurora bonds of 3 to 5 percentage points 7 Aurora in in the 30% tax bracket. 8. Aurora principal investment banker. Det company predicts a decline in interest rats with rd falling to 6% and the government bondirate to 4% although 180 acknowledge that an increase in the expected inflation rare could lead to an increase rather than a decrease in cates 9. Here is the historical record of EPS and DPS. Year EPS DPS Year EPS DPS 2006 S0.09 50.00 2014 S0.78 $0.00 2007 -0.2 0.00: 2013 0.80 0.00 3 Fate to 470 although J&J acknowledge that an increase in the expected inflation rare could lead to an increase rather than a decrease in rates. 9. Here is the historical record of EPS and DPS. Year EPS DPS Year EPS DPS 2006 $0.09 $0.00 2014 $0.78 $0.00 2007 -0.2 0.00 2015 0.80 0.00 2008 0.40 0.00 2016 1.20 0.20 2009 0.52 0.00 2017 0.95 0.40 2010 0.10 0.00 2018 1.30 0.60 2011 0.57 0.00 2019 1.60 0.80 2012 0.61 0.00 2020 2.00 1.00 2013 0.70 0.00 Assume that you are a recently hired financial analysist and that your boss, the treasurer, has asked you to estimate the company's WACC. Assume no new equity will be issues. Your cost of capital should be appropriate for use in evaluating projects that are in the same risk class as the firm's average assets now on the books, Write a report including the overall WACC calculation (Amarks) the rational of WACC different (2 marks), approaches in estimating equity costs different @marks), the common mistakes people make when estimating Wadd the pros and cons (2 marks), and give your comments on Aurora's capital structure(2 marks) The data source and reference must be in APA format