Ask Question
28 March, 18:34

The director of capital budgeting for See-Saw Inc., manufacturers of playground equipment, is considering a plan to expand production facilities in order to meet an increase in demand. He estimates that this expansion will produce a rate of return of 11%. The firm's target capital structure calls for a debt/equity ratio of 0.8. See-Saw currently has a bond issue outstanding that will mature in 25 years and has a 7% annual coupon rate. The bonds are currently selling for $804. The firm has maintained a constant growth rate of 6%. See-Saw's next expected dividend is $2 (D1), its current stock price is $40, and its tax rate is 40%. Should it undertake the expansio? n Calculate the Cost of bonds. Calculate the Cost of equity. Calculate the WACC

+2
Answers (1)
  1. 28 March, 19:31
    0
    First, find the pretax cost of debt (rd). Using a financial calculator, input the following;

    N = 25, PV = - 804, PMT = 7%*1000 = 70, FV = 1,000,

    then CPT I/Y = 9% (this is the pretax cost of debt)

    Next, use Dividend discount model (DDM) to find cost of equity (re);

    re = (D1 / Price) + g

    re = (2/40) + 0.06

    re = 0.11 or 11%

    Use D/E ratio to find weight of debt (wD) and equity (wE);

    If D/E = 0.8/1

    and D+E = V (total capital value) = 0.8 + 1 = 1.8

    then wD = 0.8/1.8 = 0.4444

    and wE = 0.5556

    WACC = wE*re + wD*rd (1-tax)

    WACC = (0.5556*0.11) + [0.4444*0.09 (1-0.40) ]

    = 0.0611 + 0.0240

    = 0.0851

    WACC is therefore = 8.51%
Know the Answer?
Not Sure About the Answer?
Find an answer to your question ✅ “The director of capital budgeting for See-Saw Inc., manufacturers of playground equipment, is considering a plan to expand production ...” in 📘 Business if you're in doubt about the correctness of the answers or there's no answer, then try to use the smart search and find answers to the similar questions.
Search for Other Answers