Part 2 TKM0844 11E IM Ch14
Chapter 14
The Cost of Capital
14-1.
Templeton’s investment of $400M will be financed with $300M in debt and $100M in equity.
Thus after the purchase, Templeton’s balance sheet (market value and book value, at t = 0) will look like this:
ASSETS
$400,000,000
DEBT
$300,000,000
$400,000,000
EQUITY
$100,000,000
$400,000,000
) = 75% in debt financing, and ( $100,000,000
) = 25% in equity
Thus Templeton is using ( $300,000,000
$400,000,000
$400,000,000 financing. Its debt and equity weights are therefore 75% and 25%, respectively.
14-2.
As noted in Checkpoint 14.1, we use the firm’s market values, not its book values, to determine its capital structure weights. Thus we don’t even need Emerson Electric’s book values to answer this problem—only its market values.
For example, to find the market value of Emerson’s equity, we solve:
WCS =
=
MV of common stock total MV of all financing sources
$26,170,000
= 66.5%.
$39,318,000
Emerson is a heavily equity-financed firm.
Here are all of Emerson’s weights:
short-term debt long-term debt common equity
book value $1,221,000
$11,927,000
$9,113,000
$22,261,000
market value $1,221,000
$11,927,000
$26,170,000
$39,318,000
% of total MV
3.11%
30.33%
66.56%
100.00%
notes
= $1,221,000/$39,318,000
= $11,927,000/$39,318,000
= $26,170,000/$39,318,000
©2011 Pearson Education, Inc. Publishing as Prentice Hall
Solutions to End of Chapter Problems—Chapter 14
377
3.11%
30.33% short-term debt long-term debt common equity
66.56%
14-3.
In this problem, we are to determine individual costs for various funding sources.
A. We have a bond with the following details: par value = $1000 coupon rate = 11% market value = $1125 maturity (years) = 10 marginal tax rate = 34%
To find the market’s required return on bonds of this risk class, we find the YTM using the bond pricing model:
1 − 1 10 $1,000
$1125 = (11%) ∗ ($1000) ∗ (1+ i ) +
,
10 i
(1 + i )
where the factor in the square brackets is the annuity present value
The Cost of Capital
14-1.
Templeton’s investment of $400M will be financed with $300M in debt and $100M in equity.
Thus after the purchase, Templeton’s balance sheet (market value and book value, at t = 0) will look like this:
ASSETS
$400,000,000
DEBT
$300,000,000
$400,000,000
EQUITY
$100,000,000
$400,000,000
) = 75% in debt financing, and ( $100,000,000
) = 25% in equity
Thus Templeton is using ( $300,000,000
$400,000,000
$400,000,000 financing. Its debt and equity weights are therefore 75% and 25%, respectively.
14-2.
As noted in Checkpoint 14.1, we use the firm’s market values, not its book values, to determine its capital structure weights. Thus we don’t even need Emerson Electric’s book values to answer this problem—only its market values.
For example, to find the market value of Emerson’s equity, we solve:
WCS =
=
MV of common stock total MV of all financing sources
$26,170,000
= 66.5%.
$39,318,000
Emerson is a heavily equity-financed firm.
Here are all of Emerson’s weights:
short-term debt long-term debt common equity
book value $1,221,000
$11,927,000
$9,113,000
$22,261,000
market value $1,221,000
$11,927,000
$26,170,000
$39,318,000
% of total MV
3.11%
30.33%
66.56%
100.00%
notes
= $1,221,000/$39,318,000
= $11,927,000/$39,318,000
= $26,170,000/$39,318,000
©2011 Pearson Education, Inc. Publishing as Prentice Hall
Solutions to End of Chapter Problems—Chapter 14
377
3.11%
30.33% short-term debt long-term debt common equity
66.56%
14-3.
In this problem, we are to determine individual costs for various funding sources.
A. We have a bond with the following details: par value = $1000 coupon rate = 11% market value = $1125 maturity (years) = 10 marginal tax rate = 34%
To find the market’s required return on bonds of this risk class, we find the YTM using the bond pricing model:
1 − 1 10 $1,000
$1125 = (11%) ∗ ($1000) ∗ (1+ i ) +
,
10 i
(1 + i )
where the factor in the square brackets is the annuity present value