Financial Ratios

Topics: Dividend, Weighted average cost of capital, Investment Pages: 9 (3365 words) Published: January 25, 2011
Part A
After-TAX Cost Debt
O’Grandy Apparel Company can calculate the after tax debt cost using YTM (CP + (FV-Nd /n) / FV +Nd /2) *2. Cp is (0.12/2) * 1000= 60 Semi-annually Fv is 1000 Nd is 995 – (0.025* 1000) = 970 N is 20*2 because it is semi-annually then you have to use Kdt= Kd+ (i-T) .The tax bracket is 40 percent. Now we can have the after tax debt when it is equal or smaller than $700000 Kd ( 1-T) = 0.1249 (1-0.4)= 0.07494. If it is more than $700000 it will be KD (1-t) = 0.18(1-0.4) = 0.108 The Cost of Preferred Equity

If o’grady Apparel Company wants to raise financing using preferred shares, it could use Po = D/K KPS=D/Pn . so, 17% annual dividend rate times $60 (stated value) which is Dt is 10.2. After that 10.2 divided by $57 which gives us 0.1789.After tax cost of preferred shares. The Cost of Common Equity

If the company needs to make the cost of common equity it has to use Po = D/(k-g) or K = D1/(Pn+g) so, the dividends per share in 2009 is 1.76. After tax cost of equity externally generated is Kex = (D1/Pn) +g . D1 is 1.79 divided by 16P0 than plus 0.15g equal 0.26. 0.238 after tax cost of equity internally generated D1 is 1.79 divided by 20 P0 than plus 0.15 equity 0.238.

Finance Case: O’Grady Apparel Company
Part B
The break point is the level of financing at which the cost of a component of financing increases (Principles of Corporate Finance pg. 525). The break point for the available reinvested profits of $1,300,000 is found by dividing it by its respective common equity capital structure weight of 65% with a result of $2 million. The available $700,000 in additional debt has a break point of $2,800,000 (see exhibit 2). The weighted average cost of capital is found by way of weighting each capital resource by its fraction of the organization’s capital structure (Principles of Corporate Finance pg. 521). The ranges that result from these break points cause the weighted average cost of capital to be 19.14% in the range of $1 - $2 million in financing, 20.57% in the range of $2,000,001 - $2,800,000 and 21.39% in the range of $2,800,001 and above (see exhibit 2). The firm would start financing with reinvested profits- being the cheapest form of financing at 19.14% and then move to the more expensive financing as needed. Finance Case Part C- O’Grady Apparel Company

The cost of capital is the rate of return a company must earn on its investment projects to increase the market value of its common shares (Principles of Corporate Finance pg. 502). The total is used to assess new projects a company may have in mind, as it is the minimum return that investors require for providing capital to their company. The value of investment opportunities available to O’Grady Apparel Company totals $4,300,000. The value of the investment opportunities available was calculated by adding all the initial investments together from investment opportunity A-G (see Exhibit 3(a)). Given this total possible investment, and the cost of capital and marginal costs of capital provided in Exhibit 2(a), the company’s overall cost of capital totaled 20.19% (see Exhibit 3(a)). Before calculating the overall cost of capital one must determine the numbers to use for calculation. First the three ranges ($2,000,000; $800,000 and $1,500,000) used in the equation were found from Part B, as well the weighted average cost of capital (19.14%; 20.57% and 21.39%) were. The overall cost of capital (20.19%) was found by taking each range and dividing them by the value of investment opportunities available which was $4,300,000 and multiplying them each by the three separate weighted average cost of capital (see Exhibit 3 (b)). Once receive three separate percentages you must add them together to get your overall cost of capital.

With an overall cost of capital of 20.19%, O’Grady’s Apparel Company would choose investment opportunity A, C, D and F because they all have expected return greater than 20.19%. Given this information we were...
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