Ace Repair

Topics: Preferred stock, Stock, Bond Pages: 7 (1589 words) Published: May 27, 2012
Ace Repair:
Q1:
A. List:
WACC= (%of debt) (after-tax cost of debt) + (% of preferred stock)(Cost of preferred stock) + (% of common equity) (Cost of common equity) =WdRd * (1-T) + WpsRps + WceRs
Wd – the weights used for debt,
Wps – the weights used for preferred equity,
Wce – the weights used for common equity,
rd – before-tax cost of debt,
rps – cost of preferred stock,
rs – cost of common equity,
T – marginal tax rate

B.
Book weight of debt=long-term debt/ total capital=30.94%
Book weight of preferred stock= Preferred stock / total capital=7.73% Book weight of common equity= common equity/ total capital=61.33%

C.
The weight of debt= 80.77%
The weight of preferred stock=16.32%
The weight of common stock=2.9%
D.
Book value are better for calculating the firm's weighted average cost of capital. Firstly, book value numbers are showed on the financial statement. Secondly, the bond rating agencies like to pay attention on book value. Thirdly, book value are more stable than market value, the book value weight can produce more stable inputs for using in capital budgeting.

Q2:
A.
Ace Repair's current method of estimating its before tax cost of debt is using a before-tax debt cost of 10 percent, that equals the coupon rate on Ace's last long-term first mortgage bond issue in 1993. And these bonds will mature in 17 years, and can be called in 3 years. So, Ace Repair's current methods of estimating it’s before tax cost would equal to the coupon rate. That means the firm is currently paying a 2% risk premium and the 8% being paid by other A-rated corporate long-term bonds. B.

It is not an appropriate measure of the firm's cost of equity. Because the earnings yield is lower than WACC. Because the earnings per share of $2.30 and a share price of $30.50, the E/P is 7.5%. And the cost of equity should be based on the dividend yield and capital gain.

Q3:
A.
The best estimate of Ace's cost of debt:
Rd=8.30%
T=40%
After-tax component cost of debt = Rd * (1-T)=4.98%
B.
Flotation costs should not be included in the component cost of debt calculation. Because most debt offerings have very low flotation cost. Such as privately placed debt. Because it is very low, so many analysts would not use flotation costs during measure the after-tax cost of debt. C.

The nominal cost of debt should be used. Because the cost of capital use the capital budgeting. And capital budgeting cash flows often used at the end of the year, can use the number show on the financial statements. D.

If the firm wants to issue 20-year long-term debt, the cost of debt of Ace's bond will be as same as the rate related to the rate corporate bonds. The premium will be paid for Ace's existing bonds, and the yield to maturity will be improved to be close to the cost that Ace will be expected to pay for new equity. E.

The company can also use the rate of cost of debt. Because the cost of debt would be the current market rate that the company need to pay. Can also use an appropriate market rate, if the Ace's outstanding debt had not been traded recently.

Q4.
A
Cost of preferred stock = Rps = Dps / (Pps * (1-F)) = 7.81%
B.
Because there is no adding tax in the calculation of the cost of preferred stock, and the preferred dividends are not the remove the taxes. C.
Preferred stock par value = $100
Retires 5 percent of the initial issue at par each year,that equals each year $5 (5%) will be retired. Flotation cost = $2.50
The preferred dividend = 8
| |Dps |Pps |Rps | |Year 1 |8+5 |100 |13.33% | |Year 2 |7.6+5 |95 |13.60% | |Year 3 |7.22+5...
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