Cost of Capital and Market Cannibalization Discussion

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A. Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 8% and to issue new preferred stock with a $2.50 per share dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share. Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees a growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys, Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys cost of capital?

B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what is Bad Boys cost of capital?

C. On page 457, your textbook details the term Cannibalization. In your own words, identify two corporations that have dealt with cannibalization and what steps were taken to overcome the cannibalization. Please provide any citations and references. Please be articulate in your responses.

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Running Head: COST OF CAPITAL AND MARKET CANNIBALIZATION

Cost of Capital and Market Cannibalization
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COST OF CAPITAL AND MARKET CANNIBALIZATION

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A. Cost of equity
The computation of Cost of equity for Bad Boys Inc.’s Equity using the dividend growth
model will be based on the weighted average costs of the capital model, which is also referred to
as the discounted model. Under this model, the weights of the different portions of the capital are
determined independently, and their weights ascertained, and then the summation of each portion
of the capital is summed up to find the total cost of capital. Therefore Bad Boys Inc.’s’ cost of
capital will be equivalent to the sum of the costs of debt, cost of common stock equity, and the
cost of preferred stock. The calculation is shown below.

New Debt
Preferred Stock
Common Stock

Weight
45%
5%
50%

Cost
8%
10%
12.50%

Tax Rate
35%
Non-Tax Deductible
Non-Tax Deductible

After-Tax Cost
5.20 %

Cost of Capital = (45% X 5.2%) + (5%X10%) + (50% X 12.50%) = 9.09 %
B. Effect of raising ...

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