Question

Dr. Smith has an opportunity to start a new cosmetic line based on wood pulp based lipstick. He needs to determine the current weighted cost of capital and the revised weighted cost of capital with the new more glamorous product line. Since Dr. Smith has hired many of his college classmates to work for his company, he decided that you were the best in corporate finance and wants you to evaluate and submit your findings to him (the president). Your entire corporate future with “Uncle Woody's Pulp Processing and Lipstick Corporation" depends on this project being completed correctly. He offers you the following data: Common Stock 200,000 shares @ $10 per share Preferred Stock $850,000 @ 7.375% Current Long Term Debt $1,300,000 @ 8% Current Dividend is $1.42 Corporate Tax Rate is 21% The company stock has increased in value at 8% per year. The cost of the new lipstick operation is $750,000. A bank loan is offered at 8.75%. New stock could be issued. A. Define the current weighted cost of capital. B. Define the weighted cost of capital if the entire project is funded by stock. C. Define the weighted cost of capital if a bank loan is obtained for the entire expansion project.

Answer 1

A Calculation Weighted Average Cost of Capital: S.No Sources 1 Common Stock (2,00,000 shares@10) 2 Preferred Stock 3 Long Term Debt Cost of Value Weight Capital(%) WACC(%) 2000000 0.48 14.2 6.84 (W.No 1) 850000 0.20 7.375 1.51 1300000 0.32 6.32 2.02 (W.No 2) 4150000 10.38 W.No 1: Calculation of Ke A) Dividend Per Share B) Face Value Per Share Ke (A/B) 1.42 10 14.2 W.No 2: Calculation of Cost of Debt A) Intrest Rate B) Corporate Tax Rate Cost of Debt (A*(1-B)) 8% 21% 6.32%

B Calculation Weighted Average Cost of Capital(Entire Project in Common Stock) Cost of Value Weight Capital(%) WACC(%) 2750000 0.56 14.2 7.97 S.No Sources 1 Common Stock (2,00,000 shares@10) + 750000 2 Preferred Stock 3 Long Term Debt 850000 1300000 0.17 0.27 (W.No 1) 7.375 6.32 (W.No 2) 1.28 1.68 4900000 10.93

C Calculation Weighted Average Cost of Capital(Entire Project in Debt Funds) S.No Cost of Sources Value Weight Capital(%) WACC(%) 1 Common Stock 2000000 0.41 14.2 5.80 (2,00,000 shares@10) (W.No 1) 2 Preferred Stock 850000 0.17 7.375 1.28 3 Long Term Debt 1300000 0.27 6.32 1.68 (W.No 2) 4 Bank Loan 750000 0.15 6.91 1.06 (W.No 3) 4900000 8.75 W.No 3: Calculation of Cost of Bank Loan A) Intrest Rate B) Corporate Tax Rate Cost of Debt (A*(1-B) 8.75% 21% 6.91%