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BUS 5111 WA U7 Final

Financial Management (University of the People)

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WRITTEN ASSIGNMENT UNIT 7

BUS 5111 Financial Management

Unit 7 Written Assignment
Comic Book Publication Group Case Study
University of the People

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Introduction
The management of Comic Book Publication Group (CBPG) wises to acquire additional

capital for operational purposes. They agree that a public debt offering in corporate bonds to the

amount of 10 million would be offered and issue the bonds at par with a 4% coupon. To do this

they need to make an analysis of the debt offering’s impact on the cost of capital. To do this type

of analysis we would have to calculate the Weighted average cost of capital (WACC).

Many companies use a combination of debt and equity to finance their businesses and,

for such companies, the overall cost of capital is derived from the weighted average cost of all

capital sources, widely known as the weighted average cost of capital (WACC) (Kenton, 2019).

“The (WACC) is a financial ratio that calculates a company’s cost of financing and acquiring

assets by comparing the debt and equity structure of the business. In other words, it measures the

weight of debt and the true cost of borrowing money or raising funds through equity to finance

new capital purchases and expansions based on the company current level of debt and equity

structure.” MyAccountingCoarse (n.d.)

Based on the case study given we are to calculate the current cost of capital of secure and

safe on a weighted average basis:

Scenario 1

Table 1: Current WACC

Description Market Value Millions)

Market Value of Debt 12

Market Value of Preferred Stock 5

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WRITTEN ASSIGNMENT UNIT 7

Market Value of Common Stock /Equity 6

Total Value of Capital 23

Interest rate on bonds =5%

Cost of preferred stock = stock- Coupon rate on Preferred stock

Coupon rate on preferred stock = Annual Dividend per share/ par value of share

=1.75/35

=5%

Cost of common stock will be 10%

Formula Extracted from MyAccountingcoarse (n.d.)

D= market value of debt= 12

P= market value of preferred stock= 5

E= market value of common stock/ equity= 6

Cost of common stock = 10%

Cost of preferred stock = 5%

Cost of debt = 5%

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WRITTEN ASSIGNMENT UNIT 7

Tax rate = (1-tax rate)

Total value of Financing 23

Current WACC = 12/23*5 %*(1-33) +5/23*5%+6/23 *10%

=1.747%=1.09%+2.61%

= 5.4425%

The company is thinking about taking on an additional debt of 10 million in bond with a

4% coupon. To calculate the new WACC we must add the additional bond to the value we

already had.

Scenario 2

Table 2: New calculation of WACC

Description Market Value (millions)

Market value of Debt 12
Market value of Preferred stock 5
Market value of common stock 6
Market value of additional debt 10
Total value of capital 33

The new WACC will now be calculated D/V*cost of Debt*(1-T) +p/V*cost of preferred stock

+E/V cost of equity+ additional debt*cost of additional debt*(1-t)

12/33*5 %*(1-33) +5/33x5%+6/33*10%+10/33x4% (1-33)

= 1.215+.7575%+1.818%+0.812%

= 4.597% or 4.6%

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Findings and Analysis

The proportion of debt in the capital structure is higher. The cost of debt is lower than the

cost of equity. Interest is tax-deductible so the post-tax cost of debt is even lower. The firm has

a lower cost of capital / WACC under the new scenario. The firm is, therefore, better off by

issuing debt in this case. However, in the current situation and in the times of liquidity shortage,

it is less likely that the company will be able to acquire additional funding from either banks or

from private funds (Hill, 2014).

Tax shield

We can say that the interest tax shields are the tax benefits from the financial structure of

a company. In the first case the cost of debt is equivalent to its bond coupon rate after deducting

tax. The rationale behind this cost of debt is based upon expenditure incurred by the company

while raising debt. Interest on debt is tax deductible, it is important to take this tax shield into

account while determining the cost of debt for the company.

In the second case, management has decided to on raising additional capital in the form

of corporate bonds at a 4% coupon rate, the company’s overall tax shield become higher. This is

due to the fact that the cost of debt is a cheaper source of raising capital. It also has benefits in

that it ensures the retention of ownership in the hands of CBPG’s management but it also

provides tax-shield in the form of interest by reducing their overall tax liability. The higher the

quantum of debt, the higher will be the tax shield offered, and equally, the higher the quantum of

debt, the higher will be the tax shield offered.

Conclusion:

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WRITTEN ASSIGNMENT UNIT 7

The firm is therefore better off by issuing debt in this case. Under the second scenario the

company has a lower cost of capital. I would approve the proposal for additional funds by means

of corporate bonds based on the second scenario.

Reference:
Finance for managers (2012). Licensed under a Creative Commons by-nc-sa 3.0 retrieved from

https://my.uopeople.edu/pluginfile.php/546007/mod_page/content/17/FinanceForManage

rs.pdf

Hill, R.A. (2014). Strategic Financial Management. Bookboon.com. Retrieved from

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WRITTEN ASSIGNMENT UNIT 7

https://bookboon.com/premium/api/library/12d7ee13-0f5e-e011-bd88-

22a08ed629e5/download/pdf

Kenton, W. (2019, Jun 5). Cost of Capital Definition. Investopedia. Retrieved from

https://www.investopedia.com/terms/c/costofcapital.asp

Marshall Hargrave (2019, June, 30) Weighted Average Cost of Capital – WACC. Retrieved from

https://www.investopedia.com/terms/w/wacc.asp

Myaccountingcourse (n.d.) Weighted Average Cost of Capital (WACC) Guide. Retrieved from

https://www.myaccountingcourse.com/financial-ratios/wacc

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