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    Rolodex, Inc: Weighted Average Cost of Capital (WACC)

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    Rolodex, Inc. would like to estimate its average cost of capital for the coming year. The capital budgeting plans call for funds totaling $200 million for the coming year. These funds will be raised from long-term debt, preferred stock, and common equity in the same proportions as their book values in the firm's balance sheet shown below:

    Rolodex, Inc. Balance Sheet (in millions of dollars)
    Current assets $110 Accounts payable $30
    Fixed assets 260 Other current liabilities 20
    Total assets $370 Long-term debt 128
    Preferred stock 32
    Common stock (20 million shares at par) 20
    Contributed capital in excess of par 30
    Retained earnings 110
    Total liabilities and equity $370

    Discussions between the firm's financial officers and the form's investment and commercial bankers have yielded the following information:

    - Rolodex's maximum borrowing is $80 million from its ban at a pretax cost of 13 percent.
    - A preferred stock can be issued at a pretax cost of 16.5 percent.
    - Rolodex expects to generate $140 million in net income. Ant earnings remaining after meeting the equity portion of the $200 million capital expedenture budget will be paid out as dividends.
    - The risk-free rate of return if 5.5 percent. The market risk premium is assumed to equal 10 percent and Rolodex's beta is estimated to be 1.2.
    - Rolodex's marginal tax rate is 40 percent.

    Compute Rolodex's weighted average cost of capital for the coming year.

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    Solution Summary

    This solution provides a tutorial on calculating the weighted average cost of capital for Rolodex.