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Written Assignment Unit 7

This document discusses calculating the weighted average cost of capital (WACC) for a company called CBPG. It provides the formulas to calculate the cost of different sources of capital including bonds, preferred stock, and common stock. It then calculates the WACC for CBPG's current capital structure and for a new capital structure assuming a $10 million bond issue. The WACC is lower for the new structure, indicating it is less risky. It also briefly explains the tax shield advantage of debt capital and defines cost of capital and WACC.

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Rachell Ann Uson
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187 views5 pages

Written Assignment Unit 7

This document discusses calculating the weighted average cost of capital (WACC) for a company called CBPG. It provides the formulas to calculate the cost of different sources of capital including bonds, preferred stock, and common stock. It then calculates the WACC for CBPG's current capital structure and for a new capital structure assuming a $10 million bond issue. The WACC is lower for the new structure, indicating it is less risky. It also briefly explains the tax shield advantage of debt capital and defines cost of capital and WACC.

Uploaded by

Rachell Ann Uson
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Running header: WRITTEN ASSIGNMENT UNIT 7

Written Assignment Unit 7

University of the People

BUS 5111 Financial Management

AY2021-T3
WRITTEN ASSIGNMENT UNIT 7 2

Solve for the current cost of capital of CBPG on a weighted average basis

The weighted average cost of capital(WACC) is a calculation of a firm’s cost of capital in which

each category of capital is proportionately weighted. All sources of capital includes common

stock, preferred stock, bonds and any other long-term debt are included in a WACC

calculation(Hargrave,2021). Therefore, it is necessary to find the cost of each source before

calculating the weighted average.

Cost of bonds formula is the interest rate multiplied by (1-tax rate),which is interest cost (1-tax

rate)=5%(1-33%)=3.35% (Hayes,2021).

Cost of preferred shares is the rate of return required by holders of a company’s preferred

stock.It is calculated by dividing the annual preferred dividened payment by the preferred stock’s

current market price(Jan,2019). The formula is cost of preferred stock= preferred dividend per

share/price per share= 1.75/35=5%

Cost of common stock=10%(given in text)

WACC with current data


current source of capital Amount of capital(million) cost of capital
bonds 12 3.35
preferred stock 5 5
common stock 6 10
total 23

WACC can be calculated with found data which is total cost divided by total

capital=(12*3.35%)+(5*5%)+(6*10%)/23=(0.402+0.25+0.6)/23=5.44%

Solve for the new cost of capital, assuming the $10 million bond issued at par with a 4%
coupon.
WRITTEN ASSIGNMENT UNIT 7 3

Cost of new debt formula is the interest rate multiplied by (1-tax rate),which is interest cost (1-

tax rate)=4%(1-33%)=2.67% (Hayes,2021).

WACC with new data


current source of capital Amount of capital(million) cost of capital
bonds 12 3.35
preferred stock 5 5
common stock 6 10
new bonds 10 2.67
total 33

WACC can be calculated with found data which is total cost divided by total
capital=(12*3.35%)+(5*5%)+(6*10%)+(10*2.67%)/33=(0.402+0.25+0.6+0.267)/33=4.51%

Describe how you approached these calculations. Also discuss the tax shield advantage that
debt capital provides, and briefly explain the cost of capital and WACC

A tax shield represents a reduction in income taxes which occurs when tax laws allow an

expense such as depreciation or interest as a deduction from taxable income. The significant

advantage of debt over equity is debt capital carries significant tax advantages as compared to

equity capital) (Jan,May 2019). The tax shield related to debt capital reduces the cost of debt and

interest paid debt is an acceptable deduction of taxable profits.

Cost of capital can be considered as the ability to cover both asset and liability expenditures

while generating a profit. It is a rate of return to help companies decide move forward on a

project or help investors determine the risk of investing in a company(McCamish,2020). The

weighted average cost of capital(WACC) is a calculation of a firm’s cost of capital in which each

category of capital is proportionately weighted. The cost of capital is calculated using the WACC

and WACC refers to the formula ad calculation while cost of capital is to describe the outcome

of the equation (McCamish,2020).


WRITTEN ASSIGNMENT UNIT 7 4

Conclusion

The operation with second scenario is less risky than that with first scenario since the WACC of

4.51% is lower than 5.44%. The company needs to consider ways like cutting debt financing

costs, lowering equity costs and capital restructuring to decrease WACC if the first scenario is

taken(Cole-Ingait,n.d).
WRITTEN ASSIGNMENT UNIT 7 5

References

Cole-Ingait,P.(n.d). How Can a Company Lower Its Weighted Average Cost of Capital?.

Retrieved from https://bizfluent.com/13351088/how-can-a-company-lower-its-weighted-

average-cost-of-capital

Hargrave,M.(2021). Weighted Average Cost of Capital(WACC). Retrieved from

https://www.investopedia.com/terms/w/wacc.asp

Hayes,A.(2021).Cost of Debt. Retrieved from

https://www.investopedia.com/terms/c/costofdebt.asp

Jan,O.(2019).Cost of Preferred Stock. Retrieved from https://xplaind.com/128767/cost-of-

preferred-stock

Jan,O.(May 2019).Tax Shielf.Retrieved from https://xplaind.com/715341/tax-

shield#:~:text=Interest%20tax%20shield%20refers%20to%20the%20reduction%20in,significant

%20tax%20advantages%20as%20compared%20to%20equity%20capital.

McCamish,B.(2020). Cost of Capital. Retrieved from

https://investinganswers.com/dictionary/c/cost-capital

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