Income before Tax, Financial management

Using the most current annual financial statements from the company
you analyzed in Phase 1, determine the percentage of the firm’s assets
that are currently be financed with debt (total liabilities), preferred
stock, and common stock (common equity). It is very possible that your
firm will have very little or no preferred stock, so in this class, the
percent would be “zero.” Your ratios should add up to 100%. You will
also need to calculate the firm’s average tax rate using the income tax
expense divided by the firm’s income before taxes. Use the following
tables:

Company

Total Assets

Total Liabilities

Total Preferred Stock

Total Common Equity

Dollar Value

% of Assets

Company

Income before Tax

Income Tax Expense

Average Tax Rate (%)

The first component to determine is the cost of debt. You mentor
suggests using the Web site that you used in the previous Phase to find
the pretax yield-to-maturity of a bond with at least 5 years left before
maturity. Using the following table, calculate the firm’s after-tax
cost of debt:

Yield to Maturity

1 – Average Tax Rate

After-tax Cost of Debt

Now you will need to calculate the cost of preferred stock. You can use the following table:

Annual Dividend

Current Value of Preferred Stock

Cost of Preferred Stock (%)

To calculate the cost of common equity, you can use the CAPM model.
Using current stock data, the yield on the 5-year treasury bond, and the
return on the market calculated in Phase 2, you can calculate the cost
of common equity using the following table:

5-year Treasury Bond Yield
(risk-free rate)

Stock’s Beta

Return on the Top 500 Stocks (market return)

Cost of Common Equity

Now, you can use the cost and ratios from above to calculate the
firm’s weighted average cost of capital (WACC) using the following
table:

After-Tax Cost of Debt

Cost of Preferred Stock

Cost of Common Equity

WACC

Unweighted Cost

Weight of Component

Weighted Cost of Component

  • After completing the required calculations, explain your results in a
    Word document, and attach the spreadsheet showing your work. Be sure to
    explain the following:

    • How would you expect the weighted average cost of capital (WACC) to
      differ if you had used market values of equity rather than the book
      value of equity, and why?
    • What would you expect would happen to the cost of equity if you had to raise it by selling new equity, and why?
    • If the after-tax cost of debt is always less expensive than equity, why don’t firms use more debt and less equity?
    • What are some of the advantages and disadvantages of raising capital by using debt?
    • How would “floatation costs” impacted the WACC, and how could they have been incorporated in the formula?

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