a) cost of equity is 8.4%
b) weighted average cost of capital is 7.19%
c) Net sales is $16,814 or $16,800 (rounded off )
Step-by-step explanation:
a) Calculation of cost of equity
Under Capital Asset Pricing Model
It takes into account the riskiness of an investment relative to the market. The model is less exact due to the estimates made in the calculation
Ke = Rf + βi × [E(Rm) – Rf]
Where:
Ke = cost of capital
Rf = Risk-free rate of return
βi = Beta of asset i
E(Rm) = Expected market return
Ke = 6% + 1.2 (8% - 6% )
Ke = 0.06 + 1.2 (0.08 -0.06) = 0.06 + 0.024 =0.084 or 8.4%
b) calculation of weighted average cost of capital
weighted average cost of capital = (VE×Re)+(VD×Rd×(1−Tc))
where:
E=Market value of the firm’s equity
= $20,000,000 (1,000,000 shares ×$20)
D=Market value of the firm’s debt
= $41,000,000 (50,000 bonds × $820)
V=E+D = $61,000,000
Re=Cost of equity = 8.4% (Refer to calculation of ke)
Rd=Cost of debt = 10%
Tc=Corporate tax rate = 34%
V=E+D= $61,000,000
The equity-linked cost of capital
(E/V)×Re= $20,000,000 ÷$61,000,000 × 0.084 = 0.028
The debt component
D/V)×Rd×(1−Tc) =
$41,000,000 ÷$61,000,000 × 0.10 ×(1-0.34) =0.044
weighted average cost of capital
= 0.028 + 0.044 = 0.719 or 7.19%
c) calculation of net sales
Net profit = Dividend = (30% of net income) $1,400 ÷30×100 = $4667
Gross profit = Net profit + Depreciation + selling and administrative expenses + interest
Gross profit = 4667+500+2500+ 347 = $8014
Net sales = Gross profit + cost of good sold
Net sales = $8014 + $8,800 = $16,814
Note :
Tax and dividend has been paid after computing Net income ., so these item does not included for net profit calculation