Berkshire Instruments

Group No. 1

Alsim, Allan Patrick

Belgica, Robie

Escaño, Ergo

Galang, Roberto

Villanueva, Jill

Borlong, Li (Michael)

SPFINMAN / G05

Prof. Alan Jezrel Solomon, MBA

1. Determine the Weighted Average Cost of Capital (WACC) based on using retained earnings in the capital structure.

In order to find the WACC, we need to find the cost of the components of the capital structure and their proportion in the total capital.

Cost of Debt – To find the cost of debt, we use the details of the bonds issued by Rollins Instruments.

The bonds have 20 years to maturity, pay interest at 9.3%, have a par value of $1,000 and are currently selling for $890.

The cost of debt is the yield to maturity (YTM) of the bonds. The YTM is the discount rate that will make the present value of interest and principal equal to the price today. The interest amount per year is $93 and the principal amount is $1,000. Using trial and error method of substituting different rates or by using the RATE function in excel, we derive the YTM as 10.65%. This is the before tax cost of debt. Since the interest amount is tax deductible, we use the after tax cost of debt in the WACC calculations. The tax rate is given as 35%. The after tax cost of debt is 10.65% X (1-0.35) = 6.92%

Proportion of Debt – The total amount of debt is 6,120,000 and the total long term capital is 18,000,000. The proportion of debt is 6,120,000/18,000,000 = 34%

Cost of Preferred Stock – We again us the Rollins Instruments preferred stock. The stock is currently trading at $60 and the annual dividends are $4.80. The preferred stock is a perpetuity and the cost is given by dividends/price. When Berkshire issues preferred stock, there would be floatation cost of $2.60. The net price to be used in the cost calculation is 60-2.60=$57.4. The cost of preferred stock is 4.80/57.4 = 8.36%

Proportion of Preferred Stock – The total amount of preferred stock is 1,080,000. The