University of Miami Economic Management Issuing Debt & Equity Discussion

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Economics

University of Miami

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Please find attached Assignment B. Please make sure to answer questions completely and fully with showing all workings in details. I am attaching the question below and i will also attach pdf files after to help you to do it.

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1. In our class discussion, we said that when you buy something, you buy ______________________________ in the context of ______________ and _____________. 2. When deciding whether to issue debt or equity, discuss the factors that would favor issuing debt. 3. Explain why a company would want to calculate its weighted average cost of capital. Be sure to include in your answer the topics of hurdle rate, optimal capital budget and optimal capital structure, as well as the marginal decision rule. 4. Suppose that you are considering the purchase of a 20–year Treasury bond, a 20–year Tesla, Inc. corporate bond, and the common stock of Tesla. The current risk premiums are provided: • • • • • • Maturity risk premium Default risk premium Real risk free rate Seniority risk premium Inflation premium Liquidity premium 3.00% 4.00% 1.00% 5.50% 0.50% 2.00% Required: Determine the required rate of return for all three securities based on the information provided above. 5. One year from today, investors anticipate that Riley Corporation’s common stock will pay a dividend of $4.00 per share. After that, investors believe that the dividend will grow at 30% per year for three years before settling down to a long-run growth rate of 8%. The required rate of return on Riley’s stock is 18%. What is the current stock price? 6. You are considering the purchase of the common stock of Herro Corporation. Given the following information, explain whether or not if you would buy the stock. Support your conclusions with computations. The current market price of Herro is $100 per share. The oneyear target estimated price is $122 per share. The dividend per share is $2.00. The beta for Herro is 1.60. The risk free rate is 2.0%. The market risk premium is 6.0%. 7. Determine the value of a share of preferred stock when the dividend rate is 8 percent and the par value is $75. The appropriate discount rate for a stock of this risk level is 10 percent. Why is the price now different from the par value? 8. Ten years ago, Costco Wholesale Corporation (COST) issued 30-year bonds that had a coupon rate of 8 percent with the interest paid semi-annually. If these bonds are now trading with a 6 percent market required yield, at what price are these bonds now selling? The par value of the bonds is $1,000. Why is the price now different from the par value? 9. Haslam Corporation considers its optimal structure to be 50 percent debt and 50 percent common stock. Haslam can borrow unlimited amounts at 9 percent. The common stock can be issued with a required return of 16%. Haslam has a tax rate of 25 percent. Haslam is considering four investment proposals: Expected Level of Investment Project Return Risk Required A 15% High $ 20,000,000 B 8% Low $ 5,000,000 C 17% High $25,000,000 D 12% Average $ 10,000,000 When Haslam evaluates a project, they consider the level of risk. If the risk level is high, Haslam adds a premium of three percent to the WACC. If the risk level is low, Haslam subtracts one percent. Required: a) Determine Haslam's weighted average cost of capital (WACC). b) Determine Haslam's optimal capital budget. 10. The Butlers are planning for their daughter's education. She is two years old and will start college in 16 years. How much will they have to set aside each year, beginning one year from today to have $500,000 when she starts college, if the interest rate is 7 percent? How much will the daughter be able to withdraw from the account each of her four years in college? 11.On October 1st, Rogers bought a house for $350,000. He paid $50,000 in cash at the time of the purchase and agreed to pay the balance in four equal annual installments that include both the principal and 8 percent interest on the declining balance. Required: a) Determine the amount of the annual payment. b) Determine the total dollars of interest that Rogers will pay for this loan. c) Determine the amount of interest that is included in the first payment. It is not necessary to complete an amortization schedule.
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Explanation & Answer

Attached.

1. In our class discussion, we said that when you buy something, you buy cash flows in the
context of time and risk.

2. When deciding whether to issue debt or equity, discuss the factors that would favor issuing
debt.
Answer:
Debt involves borrowing of funds to be repaid later plus interest equity involves
raising money by selling products. Financing your business with debt is not the
same as maxing out your credit card to fund your product development. You have
obligations such as paying customers, few enterprises and accounting of revenue.
hence, this infrastructure makes debt easy to account for making the issuing of
debt the most convenient option as it has benefits as follows;
i.
ii.
iii.
iv.
v.

Payment on debt are generally taxed deductible
Debt is cheaper in the long run than equity
Debt provides tax benefits
Debt provides more time to run the company
It allows a business to leverage a small amount of money into a much larger sum
enabling more rapid growth.

3. Explain why a company would want to calculate its weighted average cost of capital. Be
sure to include in your answer the topics of hurdle rate, optimal capital
budget, and optimal capital structure, as well as the marginal decision rule.
Answer ;
Companies would use the weighted average cost of capital because it is used in
calculating the cost of capital in which each category of capital is proportionately
weighted and all sources of capital which include long term debt, common stock,
preferred stock, bonds and any other long term debt are include...


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