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    Step 3: Calculate The Firm's New Cost of Equity With The New Capital Structure

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    Julia Robert
    The document discusses residual dividend policy and calculating WACC. It provides the following information: 1) The company's original WACC is 10.75% based on a 50% debt ratio and costs of 8% for debt and 13.5% for equity. Projects V, W, and X will be undertaken since their IRRs exceed the WACC. 2) $1.7 million will be financed through retained earnings, leaving $800,000 available for dividends after financing costs of $3.4 million for the projects. The dividend payout ratio is 32%. 3) To calculate a new WACC with a changed capital structure, the document outlines steps to calculate an unlevered

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    Step 3: Calculate The Firm's New Cost of Equity With The New Capital Structure

    Uploaded by

    Julia Robert
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    The document discusses residual dividend policy and calculating WACC. It provides the following information: 1) The company's original WACC is 10.75% based on a 50% debt ratio and costs of 8% for debt and 13.5% for equity. Projects V, W, and X will be undertaken since their IRRs exceed the WACC. 2) $1.7 million will be financed through retained earnings, leaving $800,000 available for dividends after financing costs of $3.4 million for the projects. The dividend payout ratio is 32%. 3) To calculate a new WACC with a changed capital structure, the document outlines steps to calculate an unlevered

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    The document discusses residual dividend policy and calculating WACC. It provides the following information: 1) The company's original WACC is 10.75% based on a 50% debt ratio and costs of 8% for debt and 13.5% for equity. Projects V, W, and X will be undertaken since their IRRs exceed the WACC. 2) $1.7 million will be financed through retained earnings, leaving $800,000 available for dividends after financing costs of $3.4 million for the projects. The dividend payout ratio is 32%. 3) To calculate a new WACC with a changed capital structure, the document outlines steps to calculate an unlevered

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    © All Rights Reserved
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    12 views1 page

    Step 3: Calculate The Firm's New Cost of Equity With The New Capital Structure

    Uploaded by

    Julia Robert
    The document discusses residual dividend policy and calculating WACC. It provides the following information: 1) The company's original WACC is 10.75% based on a 50% debt ratio and costs of 8% for debt and 13.5% for equity. Projects V, W, and X will be undertaken since their IRRs exceed the WACC. 2) $1.7 million will be financed through retained earnings, leaving $800,000 available for dividends after financing costs of $3.4 million for the projects. The dividend payout ratio is 32%. 3) To calculate a new WACC with a changed capital structure, the document outlines steps to calculate an unlevered

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
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    of 1

    Question#1:

    (B) Residual dividend policy The companys WACC is 8%(0.5) + 13.5%(0.5) =


    10.75%. Comparing the WACC with the project IRRs reveals that the company will
    undertake projects V, W, and X. Total financing costs for these projects is
    $3,400,000. Of this amount, 0.5($3,400,000) = $1,700,000 will be financed from
    retained earnings. Thus, $2,500,000 - $1,700,000 = $800,000 will be available for
    dividends. The payout ratio is then $800,000/$2,500,000 = 32%.
    C) You need to find the beta with no debt and the new r s with the new capital
    structure before you can calculate the firms WACC.
    Step 1:

    Calculate the firms unlevered beta using the Hamada equation:


    bL = bU[1 + (1 - T)(D/E)]
    1.2 = bU[1 + (0.6)($3/$7)]
    1.2 = 1.2571bU
    bU = 0.954545.

    Step 2:

    Calculate the firms new beta with the new capital structure:
    bL = bU[1 + (1 - T)(D/E)]
    bL = 0.954545[1 + (0.6)($5/$5)]
    bL = 1.5273.

    Step 3:

    Calculate the firms new cost of equity with the new capital
    structure:

    rs = rRF + (RPM)b

    rs = 6% + 7%(1.5273)
    rs = 16.6909%.
    Step 4:

    Calculate the firms new WACC:


    WACC = wdrd(1 - T) + wcrs
    WACC = 0.5(8.5%)(0.6) + 0.5(16.6909%)
    WACC = 10.8955% 10.90%.

    Question#2:
    (a)

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