Question

You are a member of financial analyst team at Coleman Technologies Inc. The firm is looking into a major expansion program and your part is to analyze the cost of

capital for that project. You have collected the following information:
a. Tax rate = 30%. b. 15-year, 12% coupon, semi-annual payment non-callable bonds sell for
$1,153.72. New bonds will be privately placed with no flotation cost. C. 10%, $100 par value, quarterly dividend, perpetual preferred stock sells
for $90.90
d. Common stock sells for $50. DO = $4.19 and g = 5%.
е. B = 1.2; rRF = 7%; RPM = 6%.
f. Bond-Yield Risk Premium = 4% g. Coleman Tech uses an average of the three calculations for the cost of
equity
h. Target capital structure: 25% debt, 10% preferred, 65% common equity. What is the firm's cost of capital? Hint: you need to find cost of debt, cost of
preferred stock and cost of equity before you can find WACC.

Answer 1

The firm's cost of capital (WACC) is approximately 9.12%.

Step-by-step explanation:

To calculate the weighted average cost of capital (WACC), we need to determine the cost of debt, cost of preferred stock, and cost of equity, and then apply the target capital structure weights.

1. Cost of Debt (Rd):

Using the information provided on the 15-year, 12% coupon, semi-annual payment non-callable bonds selling for $1,153.72, we can calculate the semi-annual coupon payment:
`\[ \text{Coupon Payment} = (12\% * $1,000)/(2) = $60 \]`
The yield to maturity (YTM) can be found using the bond price:

`\[ \text{YTM} = \frac{\text{Annual Coupon Payment} + \left(\frac{\text{Face Value} - \text{Bond Price}}{\text{Number of Periods}}\right)}{\frac{\text{Face Value} + \text{Bond Price}}{2}} \]`

Substituting the values and doubling the result to get the annual yield, we find the cost of debt to be approximately 10.43%.

2. Cost of Preferred Stock (Rp):

Given the 10%, $100 par value, quarterly dividend perpetual preferred stock selling for $90.90, the cost of preferred stock can be calculated as:

`\[ \text{Rp} = \frac{\text{Dividend per Quarter}}{\text{Preferred Stock Price}} \]`

Substituting the values, the cost of preferred stock is approximately 11.03%.

3. Cost of Equity (Re):

Coleman Tech uses the average of three calculations for the cost of equity, including the Capital Asset Pricing Model (CAPM), the Dividend Discount Model (DDM), and the Earnings Capitalization Model (ECM). Using the given information and averages, the cost of equity is approximately 8.70%.

4. Weighted Average Cost of Capital (WACC):

With the cost of debt, preferred stock, and equity determined, and using the target capital structure weights of 25%, 10%, and 65% respectively, the WACC is computed as:
`\[ \text{WACC} = \text{Weight of Debt} * \text{Cost of Debt} + \text{Weight of Preferred Stock} * \text{Cost of Preferred Stock} + \text{Weight of Equity} * \text{Cost of Equity} \]`

Substituting the values, we find the final answer that the firm's cost of capital is approximately 9.12%.

Answer 2

Coleman Technologies Inc.'s cost of capital or WACC is determined by calculating the costs of debt, preferred stock, and equity, adjusting for taxes, and weighting them according to the firm's target capital structure.

Step-by-step explanation:

To calculate Coleman Technologies Inc.’s cost of capital, also known as the weighted average cost of capital (WACC), we must first compute the cost of debt, cost of preferred stock, and cost of equity. Then, we use the target capital structure to weigh these costs.

Cost of Debt

The bonds are priced at $1,153.72 with a 12% annual coupon, paid semiannually, and no flotation costs. The cost of debt is calculated using the yield-to-maturity formula for bonds. Since the tax rate is 30%, we need to adjust the cost of debt for the tax shield provided by the deductibility of interest payments. This is calculated as the yield to maturity of the bond times (1 - Tax Rate).

Cost of Preferred Stock

The cost of preferred stock is calculated by dividing the annual dividend payment by the price of the preferred stock. Given a $100 par value and a 10% dividend rate, the annual dividend is $10. Dividing by the price of $90.90, we get the cost of preferred stock.

Cost of Equity

The cost of equity can be computed using three methods. First, the dividend discount model (DDM), which is $4.19*(1+5%) / $50 + 5%. Then, the Capital Asset Pricing Model (CAPM), uses the formula risk-free rate + (beta * market risk premium). Lastly, the bond yield plus risk premium method, which is the cost of debt (yield to maturity) plus a risk premium of 4%. Coleman Tech uses an average of these three methods for the cost of equity.

WACC Calculation

After calculating each component cost, the WACC is found by multiplying the cost of each type of capital by its proportion in the firm’s capital structure and then summing these products. The formula for WACC is as follows:

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By applying the target capital structure, we will get Coleman Tech’s WACC.