Question

Hello,I'm havinng an written assignment due to 27/01.
Subject 2 Part A Miller corporation has the following balance sheet Summary Balance Sheet ASSETS Cash Accounts receivable Inventories Current Assets Net Fixed Assets Total Assets LIABILITIES Accounts payable Accruals Short-term debt Current liabilities Long-term debt Preferred stock Common stock Retained earnings Total common equity Total liabilities and equity (in ,000) 30,000 60,000 60,000 150,000 150,000 300,000 30,000 30,000 15,000 75,000 90,000 15,000 30,000 90,000 120,000 300,000 The short-term debt is mainly 1M Euro bank loans at 6%. These loans aim to finance receivables and inventories on a temporal basis. During the year its level is close to zero The long-term debt consists of 7% coupon bonds, with a market price of 80 Euros, Face Value 100 Euros, and yield (YTM) 10%. The preferred stock has a par value of a 100 Euros, dividend yield of 12%, and trades in the market at 96 Euros The company has 12 million of common shares outstanding that trade at 20 Euros. The last dividend payment was 1.2 Euros, and dividends are expected to grow at an average growth rate of 8%. The stock's beta is 1.5. The yield on government bonds is 7%, and the market risk premium (Rm-Rf) is at 6%. Miller corporation is at the 40% tax bracket. . . . . Estimate the WACC of Miller corporation using (a) book values (b) market values Part B 1. What sources of capital should be included in the estimation of the cost of capital (WACC) of a firm? (<200 words) 2. In capital budgeting, should the costs be historical (embedded) costs or new (marginal) costs? (<50 words)

Answer 1

Weighted average cost of capital is the minimum return that a company offers to its creditors and all the providers of finance. All the sources of finance ( considered under liabilities ) including common stock, preferred stock or any other long term debt is included in sources while calculating WACC.

Ke = Rf + beta (Rm - Rf)

= 7% + 1.5 * 6%

= 16%.

K (long term debt) = 7% (1-0.40)

= 4.2%

WACC (BOOK VALUE )

= weight of stock * (Ke) + weight of long term debt * (Kd)

= 90000/ (120000+90000) * 4.2% + 120000 / 210000 * 16%

= 1.8 + 9.14

= 10.94

(B) in capital budgeting all cost should be new marginal costs rather than embedded historical costs.increnebral costs of caputal is the term of capital budgeting that refers to incremental costs which is being incurred for one additional unit. Capital budgeting is the process of evaluating the new decisions and new large investments whether they are feasible or not.