UU ILI the alter-tax cost of debt to calculate a firm's w will need MMM's average tax rate (which has been about 37% in recent your estimate of MMM's after-tax cost of debt? Putting all this information together, what is your estimate of MMM's WA confident are you in this estimate? Explain your answer. WACC, years). What W WAOC Home I CASE d by the high or expansion assistant During the last few years, Harry Davis Industries has been too constrained by the cost of capital to make many capital investments. Recently, though, capital cos been declining, and the company has decided to look seriously at a major pa program proposed by the marketing department. Assume that you are an assis Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis'scom capital. Jones has provided you with the following data, which she believes me relevant to your task: (1) The firm's tax rate is 40%. (2) The current price of Harry Davis's 12% coupon, semiannual payme n call bonds with 15 years remaining to maturity is $1,153.72. Harry Davis not short-term interest-bearing debt on a permanent basis. New bor would privately placed with no flotation cost. (3) The current price of the firm's 10%, $100 par value, quarterly dividit, perpetual preferred stock is $116.95. Harry Davis would incur flotation costs cal to 5% of the proceeds on a new issue. (4) Harry Davis's common stock is currently selling at $50 per share. Its last dividend (D) was $3.12, and dividends are expected to grow at a constant rate of 5.8 in the foreseeable future. Harry Davis's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% risk premium. (5) Harry Davis's target capital structure is 30% long-term debt, 10% preferred stock and 60% common equity. To help you structure the task, Leigh Jones has asked you to answer the following questions. a. (1) What sources of capital should be included when you estimate Harry Daviss weighted average cost of capital? (2) Should the component costs begun (3) Should the cost be historical em b. What is the ponent costs be fled on a before or after-tax basis costs be historical m edded costs or new (marginal) costs! et interest rate on Harry Davis's debt, and what is the component cost of this debt for WACC purposes! C. (1) What is the firm's cost of preferred stock (2 Harry Davis's preferred stock is preferred stock's yield to investors the debt. Does this suggest that yo about taxes.) d. (1) What are the two primary ways invested earning Why is there a cost associated with (3) Harry Davis doesn't plan to issue new CAPM approach, what is Ham preferred stock is niskier to investors than itse yet the yield to investors is lower than the yield te maturity on this suggest that you have made a mistake! (Hint: Think The primary ways companies raise common equity? doesn't plan to issue new shares of common stock. Using the "pproach, what is Harry Davis's estimated cost of equity? le estimated cost of it using the discounted cash flow (DCF) (2) approach the estimathat is Harry 62% of earnings, and suppose inve future. How could you use this information to Suppose the firm has historically and quity (ROE) and has paid on hings, and suppose investors expect similar values to obtain in the How could you use this information to estimate the future dividend growth rate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier? 3 Could the DCF method he anplied the growth rate were not constant? How That is the cost of equity based on the own-bond-yield-plus-judgmental-risk- nium method of equity be applied if the gre 8. What is your final estimate for the cost of equity. T? h. What is Harry Davis's weighted average cost of capital (WACC) i. What factors influence a company's WACC? 1. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What procedures can be used to estimate the risk-adjusted cost of capital for a particular division? What approaches are used to measure a division's beta? I. Harry Davis is interested in establishing a new division that will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: (1) their capital structure is 10% debt and 90% common equity; (2) their cost of debt is typically 12%; and (3) they have a beta of 1.7. Given this information, what would your estimate be for the new division's cost of capital? m. What are three types of project risk? How can each type of risk be considered when thinking about the new division's cost of capital? n. Explain in words why new common stock that is raised externally has a higher percentage cost than equity that is raised internally by retaining earnings. o. (1) Harry Davis estimates that if it issues new common stock, the flotation cost will be 15%. Harry Davis incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation cost? (2) Suppose Harry Davis issues 30-year debt with a par value of $1,000 and a coupon rate of 10%, paid annually. If flotation costs are 2%, what is the after-tax cost of debt for the new bond issue? p. What four common mistakes in estimating the WACC should Harry Davis avoid UU ILI the alter-tax cost of debt to calculate a firm's w will need MMM's average tax rate (which has been about 37% in recent your estimate of MMM's after-tax cost of debt? Putting all this information together, what is your estimate of MMM's WA confident are you in this estimate? Explain your answer. WACC, years). What W WAOC Home I CASE d by the high or expansion assistant During the last few years, Harry Davis Industries has been too constrained by the cost of capital to make many capital investments. Recently, though, capital cos been declining, and the company has decided to look seriously at a major pa program proposed by the marketing department. Assume that you are an assis Leigh Jones, the financial vice president. Your first task is to estimate Harry Davis'scom capital. Jones has provided you with the following data, which she believes me relevant to your task: (1) The firm's tax rate is 40%. (2) The current price of Harry Davis's 12% coupon, semiannual payme n call bonds with 15 years remaining to maturity is $1,153.72. Harry Davis not short-term interest-bearing debt on a permanent basis. New bor would privately placed with no flotation cost. (3) The current price of the firm's 10%, $100 par value, quarterly dividit, perpetual preferred stock is $116.95. Harry Davis would incur flotation costs cal to 5% of the proceeds on a new issue. (4) Harry Davis's common stock is currently selling at $50 per share. Its last dividend (D) was $3.12, and dividends are expected to grow at a constant rate of 5.8 in the foreseeable future. Harry Davis's beta is 1.2, the yield on T-bonds is 5.6%, and the market risk premium is estimated to be 6%. For the own-bond-yield-plus- judgmental-risk-premium approach, the firm uses a 3.2% risk premium. (5) Harry Davis's target capital structure is 30% long-term debt, 10% preferred stock and 60% common equity. To help you structure the task, Leigh Jones has asked you to answer the following questions. a. (1) What sources of capital should be included when you estimate Harry Daviss weighted average cost of capital? (2) Should the component costs begun (3) Should the cost be historical em b. What is the ponent costs be fled on a before or after-tax basis costs be historical m edded costs or new (marginal) costs! et interest rate on Harry Davis's debt, and what is the component cost of this debt for WACC purposes! C. (1) What is the firm's cost of preferred stock (2 Harry Davis's preferred stock is preferred stock's yield to investors the debt. Does this suggest that yo about taxes.) d. (1) What are the two primary ways invested earning Why is there a cost associated with (3) Harry Davis doesn't plan to issue new CAPM approach, what is Ham preferred stock is niskier to investors than itse yet the yield to investors is lower than the yield te maturity on this suggest that you have made a mistake! (Hint: Think The primary ways companies raise common equity? doesn't plan to issue new shares of common stock. Using the "pproach, what is Harry Davis's estimated cost of equity? le estimated cost of it using the discounted cash flow (DCF) (2) approach the estimathat is Harry 62% of earnings, and suppose inve future. How could you use this information to Suppose the firm has historically and quity (ROE) and has paid on hings, and suppose investors expect similar values to obtain in the How could you use this information to estimate the future dividend growth rate, and what growth rate would you get? Is this consistent with the 5.8% growth rate given earlier? 3 Could the DCF method he anplied the growth rate were not constant? How That is the cost of equity based on the own-bond-yield-plus-judgmental-risk- nium method of equity be applied if the gre 8. What is your final estimate for the cost of equity. T? h. What is Harry Davis's weighted average cost of capital (WACC) i. What factors influence a company's WACC? 1. Should the company use its overall WACC as the hurdle rate for each of its divisions? k. What procedures can be used to estimate the risk-adjusted cost of capital for a particular division? What approaches are used to measure a division's beta? I. Harry Davis is interested in establishing a new division that will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that specialized firms involved in similar projects have, on average, the following characteristics: (1) their capital structure is 10% debt and 90% common equity; (2) their cost of debt is typically 12%; and (3) they have a beta of 1.7. Given this information, what would your estimate be for the new division's cost of capital? m. What are three types of project risk? How can each type of risk be considered when thinking about the new division's cost of capital? n. Explain in words why new common stock that is raised externally has a higher percentage cost than equity that is raised internally by retaining earnings. o. (1) Harry Davis estimates that if it issues new common stock, the flotation cost will be 15%. Harry Davis incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation cost? (2) Suppose Harry Davis issues 30-year debt with a par value of $1,000 and a coupon rate of 10%, paid annually. If flotation costs are 2%, what is the after-tax cost of debt for the new bond issue? p. What four common mistakes in estimating the WACC should Harry Davis avoid