COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES

10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

TOPIC Cost of capital

ASSIGNMENT
DIRECTION & NHD Company is interested in measuring its overall cost of capital. Current investigation
has gathered the following data. The company is in a 40% tax bracket.
REQUIREMENT/
S Debt: The firm can raise debt by selling $1,000 par-value, 8% coupon interest rate, 20-
(Identify the ILOs
year bonds on which annual interest payments will be made. To sell this issue, an
to be assessed at
average discount of $30 per bond would have to be given to investors. The company also
the end of each
requirement.
must pay flotation costs of $30 per bond.
Include the rubric
or marking scheme Preferred Stock: The company can sell 8% preferred stock at its $95 per-share value.
for each The cost of issuing and selling the preferred stock is expected to be $5.00 per share.
item/requirement.) Common Stock: The company’s common stock is currently selling for $90 per share. The
firm expects to pay cash dividends of $7.00 per share next year. The firm’s dividends
have been growing at an annual rate of 6%, and this growth is expected to continue into
the future. The stock must be underpriced by $7.00 per share, and flotation costs are
expected to amount to $5.00 per share.

Retained earnings: when measuring this cost, the firm does not concern itself with the
tax bracket or brokerage fees of owners. It expects to have available $100,000 of
retained earnings in the coming year; once these retained earnings are exhausted, the
firm will use new common stock as the form of common stock equity financing.
Q1- Calculate the specific cost of each source of financing.
Q2- The firm’s capital structure weights used in calculating its weighted average cost of
capital are shown in the table below.
Source of capital Weight
Long term debt 20% A-
Calculate
Preferred stock 3
the single
0%
break point
Common stock equity 50% associated
Total 100% with the
firm’s financial situation.( Hint: this point results from exhaustion of the firm’s retained
earnings)
B- Calculate the weighted average cost of capital associated with total new
financing below the break point calculated in part (1)
C- Calculate the weighted average cost of capital associated with total new
financing above the break point calculated in part (1)

Prepared by : Reviewed / Checked: Verified by: Approved by:

1

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :
 COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES
10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

Q3- Using the results of part (d) along with the information shown in the following table on
the available investment opportunities, draw the firm’s weighted marginal cost of
capital (WMCC) schedule and investment opportunities schedule (IOS) on the same set
of axes ( Total new financing or investment on the x axis and weighted average cost of
capital and IRR on the y axis).

Internal
Iinvestment rate of return Initial
Opportunity (IRR) investment
Q4- Which, if any, of
B 11 % $ 200,000 the available
C 9.5% $ 300,000 investments do you
A 12.9 $ 250,000 recommend that the
F 16.5 $ 400,000 firm accept? Explain
E 11.8 $ 550,000 your answer. How
D 10.1 $ 600,000 much total new
G 10.5 $ 300,000 financing is required?

ASSIGNMENT
OUTPUT
Answer :
IRR means Internal rate of return
1. The IRR Rule helps companies decide whether or not to proceed with a
project.
2. A company may choose a larger project with a low IRR because it
generates greater cash flows than a small project with a high IRR.
3. A company may not rigidly follow the rule if the project has other, less
tangible, benefits.
Acceptance Rule
If IRR > Cost of capital or WACC Accept the Proposal

If IRR < Cost of capital or WACC Reject the Proposal

If IRR = Cost of capital or WACC Accept or Reject the Proposal

Prepared by : Reviewed / Checked: Verified by: Approved by:

2

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :
 COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES
10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

Invenstment oppurtunity IRR Initial Investment Return Rank

B 11.0% 200000 22000 4

C 9.5% 300000 28500 7

A 12.9% 250000 32250 2

F 16.5% 400000 66000 1

E 11.8% 550000 64900 3

D 10.1% 600000 60600 6

G 10.5% 300000 31500 5

The decision making of the investment is considered by assuming that IRR is equal to
cost of capital or WACC
Ranking logic
Ranking is considered based on higher IRR

a) Calculate the after-tax cost of debt.

After-tax cost of debt = Yield x (1 - Tax Rate) After-tax cost of debt = 0.0864 ( 1
- 0. 40) = 5.184%

b) Calculate the cost of preferred stock.

Prepared by : Reviewed / Checked: Verified by: Approved by:

3

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :
 COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES
10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

cost of preferred stock = Dividends / Net proceeds cost of preferred stock = 7.60
/ (95 - 5) = 8.445%

c) Calculate the cost of common stock.

Cost of retained earnings

Expected Dividend
Current Price
growth rate
Cost of retained earnings = 0.06 = 13.78%
Cost of new equity =
Expected Dividend
Current Price
growth rate
Cost of new equity = 7/78 + 0.06 = 14.97%
.

d) Calculate the firm's weighted average cost of capital using the capital
structure
weights shown in the following table. (Round answer to the nearest 0.1%)
WACC with retained earnings =( 0.0518 x 30) (0.0844x 0.20)+( 1378 x 0. 50)
WACC with retained earnings = 10.1%
WACC with new common equity = (0.0518 x 0. 30) + (0.0844 x 0. 20) 1497 x 0.
50)

WACC with new common equity = 10.7%

+

Q3

Prepared by : Reviewed / Checked: Verified by: Approved by:

4

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :
 COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES
10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

Q4 (Note: Weighted Marginal Cost of Capital(WMCC) is not given, it is assumed

at 15%)

Considering WACC of company is 15%, only Investment Opportunity F has high

IRR than than the company WACC. Therefore, company should accept this offer.
Total new financing required for this project is $400,000

Prepared by : Reviewed / Checked: Verified by: Approved by:

5

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :
 COLLEGE OF ADMINISTRATIVE AND FINANCIAL SCIENCES
10
Week No: _10_
Trimester: 1st / 2nd / 3rd, AY 2020-2021
BSBI525– FINANCIAL MANAGEMENT
Mini Case NO. __01_
MARKS

COURSE CODE BSBI525 COURSE TITLE Financial Management

SECTION FC/FE TIME DAYS THD ROOM
/MW
STUDENT NAME ID NO. DATE

RUBRIC / Q1: ( 1 mark each * 3) = 3 marks

MARKING Q2- a-b-c : 1 mark each
SCHEME Q3: 2 marks
Q4: 2 marks

LEARNING ASSESSMENT/MARKING FACULTY/MARKER’S FEEDBACK

ITEM CILOs MARKS MARKS AWARDED

Q1. C3 3
Q2 C3 3
Q3 C6 2
Q4 C6 2
TOTAL 10

Prepared by : Reviewed / Checked: Verified by: Approved by:

6

Dr. Gulnar Mulla Dr. Vishwas Chakranarayan Dr. Vinodh Natarajan Dr. Marluna Lim Urobio
Course Coordinator Dept. Head, BSBI Associate Dean, CAFS Dean, CAFS
Date: : Date: : Date: : Date: :