Lecture 6 – Integrated Case

Coleman Technologies Inc.

Chapter 10 (Page 382-383)

A)

1. 3 sources:
 Debt (excluding short-term debt i.e. accruals and accounts payable; both come from
suppliers; investors are not concerned with it)
 Preferred Stock
 Common Equity

2. After-tax basis

3. New (marginal) costs because undertaking major expansion project and need forward looking
measure

B) Market interest rate is talking about YTM (yield to maturity)

Data for calculation:

 No. of periods (N) = 15 x 2 = 30 (semi-annual)

 Coupon payment (PMT) = (1000 x 12%)/2 = 60
 Par value = 1000
 Market value = 1153.72 (negative in excel)
 YTM = ?

Using financial calculator, YTM = 5% (semi-annual)

Multiply by 2 to get 10% (annual)  This is YTM, not component cost of debt (after-tax)

 Tax rate = 40%

Component cost of debt = 10% x (1 – 0.40) = 6%

Calculation through Excel:

Start with negative outflow of market value (-1153.72)

Constant coupon payment from period 1 to 29 (60)

Add back par value in last period (60 + 1000)

Now use formula “= IRR (all cash flows)” to get YTM

C)

1. Perpetuity data:

 Dividend rate = 10% (annual)

 Par value = 100
 Market price = 111.10

Quarterly dividend = (100 x 10%)/4 = 2.5

rp = (2.5/111.10) x 4 = 9%

2. Cheaper to use debt because of tax benefit

D)

1. Opportunity cost – can reinvest; can invest elsewhere; can pay out dividends to shareholders
(not paying dividends may lead to shareholder activism)

2. CAPM data:
 rrf = 7%
 b = 1.2
 Market risk premium (rM - rrf)= 6%

rs = 7% + (6% x 1.2) = 14.2%

Note: Market risk premium is not the same as market return (rM)

rM = 7% + 6% = 13%

Issues: Beta is historical

E) DCF data:

 Last dividend = 4.19

 gn = 5%
 Market price = 50

Expected dividend = 4.19 x (1 + 5%) = 4.3995

rs = (4.3995/50) + 5% = 13.8%

Issues: Estimated growth rate (historical, industry, expert)

F) Plus approach data:

 Risk premium = 4%

rs = 10% + 4% = 14%

G) Range of values. Take average/mid-point = 14%

At equilibrium, CAPM and DCF should give same figure. If not, then some approximation error.

H) Floatation cost to investment bankers for underwriting (maybe even brokerage cost)

I)

1. Subtract floatation cost from market price

2. rs = [4.3995/50 x (1 – 0.15)] + 5% = 15.4%

Note: Go for retained earnings if you can as new stock is expensive, by 1.4% (15.4% vs 14%)

J) WACC = (30%)(10%)(1 – 40%) + (10%)(9%) + (60%)(14%) = 11.1%

K) External factors (economy related – interest rate and tax rate)

Internal factors (capital structure, dividend policy and investment policy – what sort of projects
willing to undertake; riskiness of projects)

L) No. Composite WACC gives average risk. Need to consider project-wise risk.