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Determining WACC given embedded assumptions

Mary Francis has just returned to her office after attending preliminary discussions with investment bankers. Her last meeting regarding the intended capital structure of Apex went well, and she calls you into her office to discuss the next steps.

"We will need to determine the required return for our intended project so that we have a decision criteria defined for the project," she says.

"Do you have the information I need to describe capital structure and to calculate the weighted average cost of capital (WACC)?" you ask.

"I do," she smiles. "We can determine the target WACC for Apex Printing, given these assumptions," she says as she hands you a piece of paper.

Weights of 40% debt and 60% common equity (no preferred equity)
A 35% tax rate
Cost of debt is 8%
Beta of the company is 1.5
Risk-free rate is 2%
Return on the market is 11%
"Great," you say. "Thanks."

"Be sure to indicate how these costs of capital might be used to determine the feasibility of the capital project," Mary says. "I want your recommendation about which is more appropriate to apply to project evaluation, too. Let me know what you think."

"One more thing," she says as she stands up to signal the end of the meeting. "You did a good job with the explanations you provided Luke the other day. Would you have time to define marginal cost of capital for me so I can include it in my discussions with investors? You seem to have a knack for making things accessible to non-financial folks."

"No problem," you say. "I'm glad my explanations are so useful!"

To recap, please assist with the following:

Describe capital structure.
Determine the WACC given the above assumptions.
Indicate how these might be useful to determine the feasibility of the capital project.
Recommend which is more appropriate to apply to project evaluation.
Define marginal cost of capital.

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Capital Structure & WACC - Apex Printing
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Abstract
This paper mainly focuses on determining the target WACC of Apex Printing. Mary Francis has just returned to her office after preliminary discussions with investment bankers. The job now is to determine the target required return for the intended project along with description of capital structure. This paper also tells us how the capital structure and WACC might be useful to determine the feasibility of the project and a recommendation of which is more appropriate to apply to project evaluation. Finally this paper also defines marginal cost of capital.

Capital Structure & WACC - Apex Printing
Introduction:
Apex printing is targeting to determine the required return of the intended project. In connection with that, this paper describes the capital structure, determines the WACC, describes the usefulness of capital structure and WACC to determine the feasibility of the project and a recommendation of which is more appropriate to evaluate the project. Marginal cost of capital is also being described.
Capital structure:
Capital structure refers to the composition of various types of financing namely debt, preferred stock and common stock. All these components are the ways by which financing can be obtained from the investors including public. The way the capital components are weighed in the capital structure also determines the risk and solvency of the company. For example, too much of debt in the capital structure increases the risk and cost of capital of a company. This is because the debt investors would then interfere in the operations of the company and may stipulate terms for further financing. Increase in debt also decreases the profits of the company because the interest cost on debt needs to be paid irrespective of the availability of profits. In a way this decreases the liquidity also because cash needs to be shed out regularly to pay interest. But the advantage of debt capital is that the interest on debt is allowed as an expense for tax purposes, thereby ...

Solution Summary

The expert determines the WACC given embedded assumptions. The information required to describe the capital structures are calculated.

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