Calculate the firm's WACC - Q & R Manufacturing
Not what you're looking for?
Can you help me with the following assignment/project?
1. As the new chief financial officers (CFO) of Q & R Manufacturing, the chief executive officer (CEO) reminded you that you are expected to try and adjust the firm's capital structure to lower its weighted average cost of capital (WACC). He asks you to address a number of questions dealing with WACC in a report to him and the firm's board of directors.
The company's balance sheet has the following information in the liabilities and stockholder equity section:
- The common stockholders have an expected return of 12%, preferred stockholders have an expected return of 6%, and the firm's bondholders purchased the firms bonds at a yield to maturity (YTM) of 4%. The firm's tax rate is 40%.
Common stock $2,000,000
Preferred stock $3,000,000
Long-term debts (bonds) $5,000,000
Total liabilities + equity = $10,000,000
Given the previous information, address the following requirements:
- Calculate the firm's WACC.
- If, as the firm's CFO, you wished to lower the WACC, make up a set of new dollar figures using different amounts of common stock, preferred stock, and long-term debt that would lower the WACC.
- Show the calculations to demonstrate that the new capital structure has a lower WACC than the original structure.
- Explain why you may want to lower the firm's WACC.
2. Often, a person or company's expected return is expressed as an opportunity cost. In your Discussion Board posting, include the following information:
- Define and explain opportunity cost.
- Explain how opportunity cost relates to expected return.
- Provide examples from Internet articles found from a credible Web site and the link to the article.
Please include references
Purchase this Solution
Solution Summary
The expert calculates the firm's WACC for the Q&R Manufacturing.
Solution Preview
==============
PART 1
Weighted Average Cost of Capital
Q & R Manufacturing weighted average cost of capital (WACC) is important information more so in its capital budgeting decision making process. WACC is computed as follows:
WACC = rps x wps + rcs x wcs + rd x wd x (1 - T)
Wherein
rps = cost of preferred stock
wps = weight of preferred stock
rcs = cost of common stock
wcs = weight of common stock
rd = cost of debt
wd = weight of debt
T = income tax rate
These variables as they pertain to Q & R Manufacturing are as follows:
rps = 6%
wps = $3,000,000/($2,000,000+$3,000,000+$5,000,000) = 30%
rcs = 12%
wcs = $2,000,000/($2,000,000+$3,000,000+$5,000,000) = 20%
rd = 4%
wd = $5,000,000/($2,000,000+$3,000,000+$5,000,000) = 50%
T = 40%
Therefore, by substitution, WACC is computed as
WACC = 6% x 30% + 12% x 20% + 4% x 50% (1 - 40%)
WACC = 1.8% + 2.4% + 1.2%
WACC = 5.4%
Now, assuming that the company wants to lower its WACC, the following new capital structure is assumed:
Common stock $1,000,000
Preferred stock $0
Long-term debts (bonds) $9,000,000
Total liabilities + equity = $10,000,000
Given this new capital structure, the weights of the different components of the company's capital are as follows
wps = $0/($1,000,000+$0+$9,000,000) = 0%
wcs = $1,000,000/($1,000,000+$0+$9,000,000) = 10%
wd = $9,000,000/($1,000,000+$0+$9,000,000) = 90%
Then, the company's new WACC is computed as follows
WACC = 6% x 0% + 12% x 10% + 4% x 90% (1 - 40%)
WACC = 0.0% + 1.2% + 2.16%
WACC = 3.36%
Optimal Capital Structure
Unfortunately, managing the firm's capital structure is much more than just making up a set of new dollar figures and assigning them to the different components of this structure. Fortunately, there are several sets of management ...
Purchase this Solution
Free BrainMass Quizzes
Change and Resistance within Organizations
This quiz intended to help students understand change and resistance in organizations
Basics of corporate finance
These questions will test you on your knowledge of finance.
Paradigms and Frameworks of Management Research
This quiz evaluates your understanding of the paradigm-based and epistimological frameworks of research. It is intended for advanced students.
SWOT
This quiz will test your understanding of the SWOT analysis, including terms, concepts, uses, advantages, and process.
Organizational Behavior (OB)
The organizational behavior (OB) quiz will help you better understand organizational behavior through the lens of managers including workforce diversity.