Description
Homework Set #4: Chapters 9, 10, & 11
Due Week 8 and worth 100 points
Directions: Answer the following questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link above.
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.
Explanation & Answer
Cost of Capital A. Bad Boys, Inc. Cost of Capital The cost of capital is the funds that are used by the investors in funding a business. In some businesses, the cost of capital can refer to the cost of equity depending on the financing mode. In some cases of businesses owned by a sole proprietor, it is called the cost of debt. The computation of the cost of capital for businesses is determined by the use of the weighted average cost of capital (WACC). Capital budgeting usually bases the decisions made on the cost of capital (Grabowski, Roger, James. Harrington, and Carla). The cost of capital is the level that any business must overcome to generate profit. The weighted average cost of capital that is used to determine the cost of capital is based on the capital structure and the cost of equity. The weighted average cost f capital works in the following manner: E = Bad Boys, Inc. market value (equity) D = Bad Boys, Inc. market value (debt) V = Bad Boys, Inc. total value in the market (E +D) Re = the cost of equity Rd = the debt cost T = the set tax rate of Bad Boys, Inc. WACC = E *Re + D*Rd*(1-T) WACC = 20*0.5 + 20*0.45*(1-0.35) WACC = 10 + 9*(0.65) WACC...
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