# 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 |
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?

- How would you expect the weighted average cost of capital (WACC) to

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