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ACE industrial machines

Coca Bean Inc. Coca Bean, Inc. recently hired y n, Inc. recently hired you as a financial analyst One of your first assignmen
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Answer #1

1). Cost of existing debt: FV = 1,000; PMT = 8%*1,000 = 80; PV = 1,035; N = 16, solve for RATE.

YTM = 7.61%

After-tax cost of existing debt (rd) = YTM*(1-Tax rate) = 7.61%*(1-34%) = 5.03%

Cost of new debt: FV = 1,000; PMT = 80; PV = 1,035 - transaction cost = 1,035-3.29 = 1,031.71, solve for RATE.

YTM = 7.65%

After-tax cost of debt = 7.65%*(1-34%) = 5.05%

2). Cost of retained earnings (re): D0 = 2.50; growth rate (g) = 6%; P0 = 35

re = (D1/P0) + g = (2.50*(1+6%)/35) + 6% = 13.57%

Cost of retained earnings (using CAPM) = risk-free rate + beta*(market return - risk-free rate)

= 1.75% + 1.54*(5.46%-1.75%) = 7.46%

The question does not specify which cost of retained earnings to use. Usually, analysts use their discretion and take a cost which is in line with the industry and the company. Here, we will take an average of both.

Cost of retained earnings = (13.57%+7.46%)/2 = 10.52%

Cost of new stock (cs) = (D1/(P0-transaction cost)) + g

= .(2.5*(1+6%)/(35-7.13)) + 6% = 15.51%

3). Again the question does not specify how capital is to be funded whether by existing capital or new capital. We will calculate both.

WACC (using existing capital) = (weight of debt*after-tax cost of debt) + (weight of equity*cost of equity)

= (45%*5.03%) + (55%*10.52%) = 8.05%

WACC (using new capital) = (45%*5.05%) + (55%*15.51%) = 10.80%

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