**CHAPTER xxxxxxx align="center"> **

**THE xxxxxxx OF CAPITAL**

**FOCUS**

xxxxxxx xxxxxxx of xxxxxxx was introduced xxxxxxx Chapter 10 xxxxxxx an xxxxxxx xxxxxxx capital budgeting, xxxxxxx the student xxxxxxx already familiar xxxxxxx the basic xxxxxxx Here we xxxxxxx on the xxxxxxx xxxxxxx of xxxxxxx calculation and xxxxxxx importance of xxxxxxx market xxxxxxx xxxxxxx cost of xxxxxxx is a xxxxxxx calculation. Many xxxxxxx have trouble xxxxxxx their arms xxxxxxx it. It's xxxxxxx xxxxxxx to xxxxxxx an overview xxxxxxx the whole xxxxxxx before xxxxxxx xxxxxxx in the xxxxxxx In other xxxxxxx it’s a xxxxxxx idea to xxxxxxx some time xxxxxxx about the xxxxxxx xxxxxxx capital xxxxxxx an “average xxxxxxx the company xxxxxxx for xxxxxxx xxxxxxx of its xxxxxxx money, and xxxxxxx knowing the xxxxxxx of capital xxxxxxx important.

**TEACHING OBJECTIVES**

xxxxxxx studying this xxxxxxx xxxxxxx student xxxxxxx appreciate the xxxxxxx of the xxxxxxx average xxxxxxx xxxxxxx concept, be xxxxxxx to calculate xxxxxxx capital costs, xxxxxxx develop the xxxxxxx as well xxxxxxx an MCC xxxxxxx xxxxxxx PURPOSE xxxxxxx THE COST xxxxxxx CAPITAL

The xxxxxxx of xxxxxxx xxxxxxx a benchmark xxxxxxx evaluating capital xxxxxxx projects and xxxxxxx the firm's xxxxxxx required rate xxxxxxx return.

II. COST xxxxxxx xxxxxxx CONCEPTS

xxxxxxx Capital Components

xxxxxxx Equity, and xxxxxxx Stock.

xxxxxxx xxxxxxx Structure

Structure xxxxxxx a mix xxxxxxx components. The xxxxxxx structure and xxxxxxx proportions in xxxxxxx money is xxxxxxx xxxxxxx raised.

xxxxxxx Returns on xxxxxxx and the xxxxxxx of xxxxxxx xxxxxxx The conceptual xxxxxxx between the xxxxxxx an investor xxxxxxx and the xxxxxxx of a xxxxxxx component.

xxxxxxx xxxxxxx Weighted xxxxxxx Calculation - xxxxxxx WACC

A xxxxxxx of xxxxxxx xxxxxxx average idea xxxxxxx how it xxxxxxx E. Capital xxxxxxx and Cost xxxxxxx Book Versus xxxxxxx Values

The xxxxxxx xxxxxxx structure xxxxxxx cost can xxxxxxx based on xxxxxxx book xxxxxxx xxxxxxx values and xxxxxxx xxxxxxx of why xxxxxxx values are xxxxxxx CALCULATING THE xxxxxxx A. Developing xxxxxxx xxxxxxx Structures

xxxxxxx to develop xxxxxxx structure based xxxxxxx the xxxxxxx xxxxxxx of the xxxxxxx securities.

B. xxxxxxx Component Costs xxxxxxx Capital

Adjusting xxxxxxx for taxes xxxxxxx flotation cost xxxxxxx xxxxxxx at xxxxxxx costs.

C. xxxxxxx the Weights xxxxxxx Costs xxxxxxx xxxxxxx MARGINAL COST xxxxxxx CAPITAL (MCC)

xxxxxxx The Break xxxxxxx MCC When xxxxxxx Earnings Run xxxxxxx Defining the xxxxxxx xxxxxxx calculating xxxxxxx position.

B. xxxxxxx MCC Schedule

xxxxxxx the xxxxxxx xxxxxxx and its xxxxxxx THE COST xxxxxxx CAPITAL - xxxxxxx COMPREHENSIVE EXAMPLE

xxxxxxx detailed example xxxxxxx the calculation xxxxxxx xxxxxxx WACC xxxxxxx MCC.

VI. A xxxxxxx MISTAKE - xxxxxxx SEPARATELY xxxxxxx xxxxxxx The fallacy xxxxxxx evaluating a xxxxxxx that comes xxxxxxx its own xxxxxxx financing on xxxxxxx basis of xxxxxxx xxxxxxx of xxxxxxx that financing xxxxxxx than the xxxxxxx Compare xxxxxxx xxxxxxx of capital xxxxxxx with the xxxxxxx of the xxxxxxx return on xxxxxxx stock investment xxxxxxx by an xxxxxxx xxxxxxx both xxxxxxx to the xxxxxxx of the xxxxxxx How xxxxxxx xxxxxxx very risky xxxxxxx project be xxxxxxx in the xxxxxxx budgeting/cost of xxxxxxx context?

**ANSWER:** An xxxxxxx won't invest xxxxxxx xxxxxxx stock xxxxxxx its expected xxxxxxx exceeds his xxxxxxx her xxxxxxx xxxxxxx Similarly, a xxxxxxx won't invest xxxxxxx a project xxxxxxx its expected xxxxxxx traditionally called xxxxxxx IRR, exceeds xxxxxxx xxxxxxx cost xxxxxxx capital. Hence xxxxxxx cost of xxxxxxx functions xxxxxxx xxxxxxx a required xxxxxxx with respect xxxxxxx business investments. xxxxxxx fact, the xxxxxxx can be xxxxxxx interchangeably.

Investors’ xxxxxxx xxxxxxx increase xxxxxxx the risk xxxxxxx the investment xxxxxxx considered xxxxxxx xxxxxxx SML). The xxxxxxx of capital, xxxxxxx is the xxxxxxx regardless of xxxxxxx investment being xxxxxxx In this xxxxxxx xxxxxxx concepts xxxxxxx different.

** Therefore xxxxxxx doesn't make xxxxxxx to xxxxxxx xxxxxxx projects with xxxxxxx cost of xxxxxxx A rate xxxxxxx upward for xxxxxxx is more xxxxxxx Define the xxxxxxx xxxxxxx capital xxxxxxx and capital xxxxxxx Why is xxxxxxx structure xxxxxxx xxxxxxx the cost xxxxxxx capital concept? xxxxxxx many capital xxxxxxx discussions, preferred xxxxxxx is lumped xxxxxxx with either xxxxxxx xxxxxxx common xxxxxxx With respect xxxxxxx the cost xxxxxxx capital, xxxxxxx xxxxxxx treated separately. xxxxxxx ** Capital components xxxxxxx the sources xxxxxxx capital, generally xxxxxxx equity and xxxxxxx stock. Capital xxxxxxx xxxxxxx the xxxxxxx in which xxxxxxx components are xxxxxxx It xxxxxxx xxxxxxx to the xxxxxxx of capital, xxxxxxx it provides xxxxxxx proportions in xxxxxxx we mix xxxxxxx costs to xxxxxxx xxxxxxx an xxxxxxx cost of xxxxxxx Preferred is xxxxxxx separately xxxxxxx xxxxxxx generally has xxxxxxx cost that's xxxxxxx from either xxxxxxx cost of xxxxxxx or the xxxxxxx of equity.

3. xxxxxxx xxxxxxx a xxxxxxx financial analyst xxxxxxx for a xxxxxxx that's xxxxxxx xxxxxxx 100 years xxxxxxx The CFO xxxxxxx asked you xxxxxxx a young xxxxxxx of the xxxxxxx staff to xxxxxxx xxxxxxx in xxxxxxx the firm's xxxxxxx structure for xxxxxxx purpose xxxxxxx xxxxxxx its cost xxxxxxx capital. As xxxxxxx both leave xxxxxxx CFO's office, xxxxxxx accounting colleague xxxxxxx that this xxxxxxx xxxxxxx really xxxxxxx to be xxxxxxx because he xxxxxxx has xxxxxxx xxxxxxx In preparing xxxxxxx latest annual xxxxxxx he worked xxxxxxx the capital xxxxxxx of the xxxxxxx sheet, and xxxxxxx xxxxxxx values xxxxxxx debt, preferred xxxxxxx and equity xxxxxxx his xxxxxxx xxxxxxx says that xxxxxxx two of xxxxxxx can summarize xxxxxxx into a xxxxxxx in five xxxxxxx and then xxxxxxx xxxxxxx for xxxxxxx beer. How xxxxxxx you react xxxxxxx why? xxxxxxx xxxxxxx fact that xxxxxxx firm is xxxxxxx old relevant? xxxxxxx You should xxxxxxx tell your xxxxxxx that using xxxxxxx xxxxxxx of xxxxxxx and equity xxxxxxx result in xxxxxxx cost xxxxxxx xxxxxxx that reflects xxxxxxx conditions. Since xxxxxxx cost of xxxxxxx will be xxxxxxx to evaluate xxxxxxx projects, a xxxxxxx xxxxxxx reflects xxxxxxx capital markets xxxxxxx more appropriate. xxxxxxx is xxxxxxx xxxxxxx using market xxxxxxx for capital xxxxxxx The fact xxxxxxx the firm xxxxxxx old makes xxxxxxx likely that xxxxxxx xxxxxxx will xxxxxxx very different xxxxxxx market values. xxxxxxx it xxxxxxx xxxxxxx book approach xxxxxxx more undesirable.

4. xxxxxxx investor's return xxxxxxx the company's xxxxxxx are opposite xxxxxxx of the xxxxxxx xxxxxxx but xxxxxxx quite. Explain.

**ANSWER:** xxxxxxx money paid xxxxxxx investors xxxxxxx xxxxxxx company's cost. xxxxxxx certain third xxxxxxx are involved xxxxxxx make the xxxxxxx paid and xxxxxxx different. Flotation xxxxxxx xxxxxxx paid xxxxxxx investment bankers, xxxxxxx companies receive xxxxxxx than xxxxxxx xxxxxxx for securities. xxxxxxx makes the xxxxxxx costs higher xxxxxxx the investors' xxxxxxx Interest is xxxxxxx deductible, so xxxxxxx xxxxxxx essentially xxxxxxx part of xxxxxxx company's interest xxxxxxx to xxxxxxx xxxxxxx makes the xxxxxxx of debt xxxxxxx than the xxxxxxx return.

5. There's xxxxxxx issue of xxxxxxx versus market xxxxxxx xxxxxxx respect xxxxxxx both the xxxxxxx of capital xxxxxxx and xxxxxxx xxxxxxx of those xxxxxxx used in xxxxxxx weights. We're xxxxxxx to accept xxxxxxx approximation for xxxxxxx weights, but xxxxxxx xxxxxxx the xxxxxxx Why?

**ANSWER:** We xxxxxxx raise money xxxxxxx the xxxxxxx xxxxxxx of the xxxxxxx structure, so xxxxxxx set of xxxxxxx is an xxxxxxx of what's xxxxxxx to happen xxxxxxx xxxxxxx firm xxxxxxx issues securities. xxxxxxx costs, however, xxxxxxx close xxxxxxx xxxxxxx what will xxxxxxx be encountered xxxxxxx the market. xxxxxxx those costs xxxxxxx vary considerably, xxxxxxx pays to xxxxxxx xxxxxxx latest xxxxxxx of market xxxxxxx There is, xxxxxxx an xxxxxxx xxxxxxx all this. xxxxxxx cost of xxxxxxx is not xxxxxxx precise calculation, xxxxxxx expending a xxxxxxx deal of xxxxxxx xxxxxxx excessive xxxxxxx in any xxxxxxx part is xxxxxxx A xxxxxxx xxxxxxx investment projects xxxxxxx under consideration xxxxxxx your company. xxxxxxx calculated the xxxxxxx of capital xxxxxxx on market xxxxxxx xxxxxxx rates, xxxxxxx analyzed the xxxxxxx using IRR xxxxxxx NPV. xxxxxxx xxxxxxx are marginally xxxxxxx While watching xxxxxxx news last xxxxxxx you learned xxxxxxx most economists xxxxxxx a rise xxxxxxx xxxxxxx rates xxxxxxx the next xxxxxxx Should you xxxxxxx your xxxxxxx xxxxxxx light of xxxxxxx information? Why?

**ANSWER:** xxxxxxx Since rates xxxxxxx expected to xxxxxxx capital over xxxxxxx next year xxxxxxx xxxxxxx be xxxxxxx expensive than xxxxxxx raised today xxxxxxx be. xxxxxxx xxxxxxx your cost xxxxxxx capital is xxxxxxx understated. If xxxxxxx projects are xxxxxxx they would xxxxxxx be unacceptable xxxxxxx xxxxxxx coming xxxxxxx You should xxxxxxx your cost xxxxxxx capital xxxxxxx xxxxxxx expected rates xxxxxxx rework your xxxxxxx Then show xxxxxxx decision makers xxxxxxx sets of xxxxxxx explaining your xxxxxxx xxxxxxx may xxxxxxx may not xxxxxxx with the xxxxxxx Establishing xxxxxxx xxxxxxx of equity xxxxxxx the most xxxxxxx and difficult xxxxxxx of developing xxxxxxx firm's cost xxxxxxx capital. Outline xxxxxxx xxxxxxx behind xxxxxxx problem and xxxxxxx approaches available xxxxxxx making xxxxxxx xxxxxxx of it.

**ANSWER:** xxxxxxx cost of xxxxxxx is related xxxxxxx the return xxxxxxx an investment xxxxxxx the firm's xxxxxxx xxxxxxx return xxxxxxx on dividends xxxxxxx price movements xxxxxxx can xxxxxxx xxxxxxx estimated. The xxxxxxx on bonds xxxxxxx preferred stock xxxxxxx exact, because xxxxxxx and principal xxxxxxx and preferred xxxxxxx xxxxxxx specified xxxxxxx the contracts xxxxxxx investors.

Because xxxxxxx this xxxxxxx xxxxxxx estimate the xxxxxxx of equity xxxxxxx on projected xxxxxxx rates and xxxxxxx The growth xxxxxxx approach uses xxxxxxx xxxxxxx model. xxxxxxx are two xxxxxxx approaches. One xxxxxxx the xxxxxxx xxxxxxx the other xxxxxxx a risk xxxxxxx to the xxxxxxx the firm xxxxxxx on its xxxxxxx Retained earnings xxxxxxx xxxxxxx by xxxxxxx firm's internal xxxxxxx and are xxxxxxx reinvested xxxxxxx xxxxxxx more money xxxxxxx the company xxxxxxx its shareholders. xxxxxxx such funds xxxxxxx zero cost xxxxxxx the company. xxxxxxx xxxxxxx statement xxxxxxx or false? xxxxxxx False. Retained xxxxxxx belong xxxxxxx xxxxxxx and have xxxxxxx reinvested for xxxxxxx without their xxxxxxx permission. Stockholders xxxxxxx therefore entitled xxxxxxx the same xxxxxxx xxxxxxx those xxxxxxx funds that xxxxxxx receive on xxxxxxx price xxxxxxx xxxxxxx stock. The xxxxxxx of retained xxxxxxx therefore, is xxxxxxx same as xxxxxxx cost of xxxxxxx received from xxxxxxx xxxxxxx of xxxxxxx except for xxxxxxx absence of xxxxxxx costs.

9. xxxxxxx xxxxxxx marginal cost xxxxxxx capital (MCC) xxxxxxx explain in xxxxxxx why it xxxxxxx undergoes a xxxxxxx function increase xxxxxxx xxxxxxx more xxxxxxx is raised xxxxxxx a budget xxxxxxx The xxxxxxx xxxxxxx of capital xxxxxxx the cost xxxxxxx the next xxxxxxx raised. As xxxxxxx money is xxxxxxx during a xxxxxxx xxxxxxx investors xxxxxxx concerned about xxxxxxx and demand xxxxxxx returns. xxxxxxx xxxxxxx returns increase, xxxxxxx does the xxxxxxx of capital xxxxxxx and the xxxxxxx The first xxxxxxx generally occurs xxxxxxx xxxxxxx is xxxxxxx factor. When xxxxxxx firm exhausts xxxxxxx retained xxxxxxx xxxxxxx must obtain xxxxxxx equity by xxxxxxx stock. But xxxxxxx stock involves xxxxxxx cost, which xxxxxxx it more xxxxxxx xxxxxxx retained xxxxxxx After the xxxxxxx in the xxxxxxx caused xxxxxxx xxxxxxx up retained xxxxxxx the schedule xxxxxxx be expected xxxxxxx remain flat xxxxxxx Is this xxxxxxx right or xxxxxxx xxxxxxx wrong, xxxxxxx what can xxxxxxx expected to xxxxxxx to xxxxxxx xxxxxxx and why.

**ANSWER:** xxxxxxx statement is xxxxxxx As more xxxxxxx is raised xxxxxxx a single xxxxxxx investors become xxxxxxx xxxxxxx risk xxxxxxx demand higher xxxxxxx As required xxxxxxx increase, xxxxxxx xxxxxxx the cost xxxxxxx capital components xxxxxxx the WACC. xxxxxxx implies that xxxxxxx MCC will xxxxxxx step function xxxxxxx xxxxxxx more xxxxxxx is raised.

11. xxxxxxx is it xxxxxxx to xxxxxxx xxxxxxx WACC as xxxxxxx highest step xxxxxxx the MCC xxxxxxx the IOS? xxxxxxx anything lost xxxxxxx using this xxxxxxx xxxxxxx the xxxxxxx is defined xxxxxxx the highest xxxxxxx on xxxxxxx xxxxxxx under the xxxxxxx we don't xxxxxxx to worry xxxxxxx changing it xxxxxxx more money xxxxxxx raised. Since xxxxxxx xxxxxxx generally xxxxxxx in descending xxxxxxx of IRR, xxxxxxx the xxxxxxx xxxxxxx will not xxxxxxx anything to xxxxxxx left of xxxxxxx intersection, so xxxxxxx is lost xxxxxxx using that xxxxxxx xxxxxxx throughout.

**BUSINESS xxxxxxx You're the xxxxxxx hired CFO xxxxxxx a xxxxxxx xxxxxxx company. The xxxxxxx held firm xxxxxxx capitalized with xxxxxxx million in xxxxxxx equity and xxxxxxx million in xxxxxxx xxxxxxx bank xxxxxxx The construction xxxxxxx is quite xxxxxxx so xxxxxxx xxxxxxx 20% to xxxxxxx are normally xxxxxxx on equity xxxxxxx The bank xxxxxxx currently charging xxxxxxx on the xxxxxxx xxxxxxx but xxxxxxx rates are xxxxxxx to rise xxxxxxx the xxxxxxx xxxxxxx Your boss, xxxxxxx owner, started xxxxxxx career as xxxxxxx carpenter and xxxxxxx an excellent xxxxxxx of day-to-day xxxxxxx xxxxxxx he xxxxxxx little about xxxxxxx Business has xxxxxxx good xxxxxxx xxxxxxx several expansion xxxxxxx are under xxxxxxx A cash xxxxxxx projection has xxxxxxx made for xxxxxxx You're satisfied xxxxxxx xxxxxxx estimates xxxxxxx reasonable. **

**
**

The xxxxxxx has called xxxxxxx in xxxxxxx xxxxxxx to being xxxxxxx about the xxxxxxx He instinctively xxxxxxx that some xxxxxxx financially marginal xxxxxxx may not xxxxxxx xxxxxxx to xxxxxxx company, but xxxxxxx doesn't know xxxxxxx to xxxxxxx xxxxxxx or to xxxxxxx among the xxxxxxx that are xxxxxxx viable.

Assuming xxxxxxx owner understands xxxxxxx concept of xxxxxxx xxxxxxx investment, xxxxxxx a brief xxxxxxx explaining the xxxxxxx of xxxxxxx xxxxxxx cost of xxxxxxx and how xxxxxxx can solve xxxxxxx problem. Don't xxxxxxx into the xxxxxxx mechanics of xxxxxxx xxxxxxx but xxxxxxx use the xxxxxxx given above xxxxxxx make xxxxxxx xxxxxxx estimate of xxxxxxx company's cost xxxxxxx capital, and xxxxxxx the result xxxxxxx your memo.

**ANSWER:** xxxxxxx business has xxxxxxx xxxxxxx for xxxxxxx funds it xxxxxxx We call xxxxxxx payment xxxxxxx xxxxxxx of the xxxxxxx and generally xxxxxxx it as xxxxxxx percentage like xxxxxxx interest rate. xxxxxxx money, comes xxxxxxx xxxxxxx and xxxxxxx and the xxxxxxx of each xxxxxxx closely xxxxxxx xxxxxxx the returns xxxxxxx firm pays xxxxxxx investors.

When xxxxxxx firm considers xxxxxxx that use xxxxxxx money, it's xxxxxxx xxxxxxx estimate xxxxxxx cost in xxxxxxx pooled sense. xxxxxxx we xxxxxxx xxxxxxx we call xxxxxxx money capital xxxxxxx develop a xxxxxxx cost figure xxxxxxx it. Under xxxxxxx logic, the xxxxxxx xxxxxxx of xxxxxxx is an xxxxxxx of the xxxxxxx of xxxxxxx xxxxxxx equity where xxxxxxx average is xxxxxxx by the xxxxxxx of debt xxxxxxx equity in xxxxxxx In our xxxxxxx xxxxxxx company xxxxxxx financed with xxxxxxx mix that's xxxxxxx 40% xxxxxxx xxxxxxx 60% debt. xxxxxxx cost of xxxxxxx is about xxxxxxx while the xxxxxxx tax cost xxxxxxx debt is xxxxxxx xxxxxxx neighborhood xxxxxxx 9%. That xxxxxxx our overall xxxxxxx of xxxxxxx xxxxxxx between 13% xxxxxxx 14%. Once xxxxxxx know what xxxxxxx money costs, xxxxxxx apparent

that we xxxxxxx never use xxxxxxx xxxxxxx a xxxxxxx that returns xxxxxxx than that xxxxxxx Now xxxxxxx xxxxxxx to projects xxxxxxx a moment. xxxxxxx earn returns xxxxxxx invested funds xxxxxxx "Internal Rates xxxxxxx Return (IRRs)". xxxxxxx xxxxxxx the xxxxxxx on just xxxxxxx money in xxxxxxx bank xxxxxxx xxxxxxx interest rate xxxxxxx bank pays.

xxxxxxx among projects xxxxxxx conceptually simple. xxxxxxx risks are xxxxxxx the same, xxxxxxx xxxxxxx projects xxxxxxx the highest xxxxxxx *But* it xxxxxxx makes xxxxxxx xxxxxxx undertake a xxxxxxx that doesn't xxxxxxx at least xxxxxxx much as xxxxxxx cost of xxxxxxx put into xxxxxxx xxxxxxx do xxxxxxx would be xxxxxxx plan to xxxxxxx money! xxxxxxx xxxxxxx it wouldn't xxxxxxx much sense xxxxxxx put company xxxxxxx in a xxxxxxx account paying xxxxxxx because the xxxxxxx xxxxxxx us xxxxxxx Now put xxxxxxx ideas of xxxxxxx of xxxxxxx xxxxxxx IRR together. xxxxxxx projects we're xxxxxxx all have xxxxxxx IRRs. Anything xxxxxxx an IRR xxxxxxx 14% isn't xxxxxxx xxxxxxx idea, xxxxxxx that's less xxxxxxx what we xxxxxxx for xxxxxxx xxxxxxx we'll put xxxxxxx it. Projects xxxxxxx IRRs between xxxxxxx and about xxxxxxx are pretty xxxxxxx Those with xxxxxxx xxxxxxx may xxxxxxx ok if xxxxxxx cash projections xxxxxxx reasonable xxxxxxx xxxxxxx risks aren't xxxxxxx of line.

2. xxxxxxx the CFO xxxxxxx a small xxxxxxx that is xxxxxxx a new xxxxxxx xxxxxxx president xxxxxxx several other xxxxxxx of management xxxxxxx very xxxxxxx xxxxxxx the idea xxxxxxx reasons related xxxxxxx engineering and xxxxxxx rather than xxxxxxx You've analyzed xxxxxxx proposal by xxxxxxx xxxxxxx budgeting xxxxxxx and found xxxxxxx it fails xxxxxxx IRR xxxxxxx xxxxxxx tests using xxxxxxx cost of xxxxxxx based on xxxxxxx returns. The xxxxxxx is that xxxxxxx rates have xxxxxxx xxxxxxx in xxxxxxx last year, xxxxxxx the cost xxxxxxx capital xxxxxxx xxxxxxx high.

You've xxxxxxx your results xxxxxxx the management xxxxxxx who are xxxxxxx disappointed. In xxxxxxx they'd like xxxxxxx xxxxxxx a xxxxxxx to discredit xxxxxxx analysis, so xxxxxxx can xxxxxxx xxxxxxx ahead with xxxxxxx project. You've xxxxxxx your analysis, xxxxxxx everything seems xxxxxxx understood except xxxxxxx one point. xxxxxxx xxxxxxx insists xxxxxxx the use xxxxxxx returns currently xxxxxxx to xxxxxxx xxxxxxx a basis xxxxxxx the cost xxxxxxx capital components xxxxxxx make sense. xxxxxxx vice president xxxxxxx marketing put xxxxxxx xxxxxxx as xxxxxxx "Two years xxxxxxx we borrowed xxxxxxx million xxxxxxx xxxxxxx We haven't xxxxxxx it back, xxxxxxx we're still xxxxxxx interest payments xxxxxxx $100,000 every xxxxxxx Clearly, our xxxxxxx xxxxxxx debt xxxxxxx 10% and xxxxxxx the 14% xxxxxxx want xxxxxxx xxxxxxx If you'd xxxxxxx "real" cost xxxxxxx debt, as xxxxxxx as of xxxxxxx and preferred xxxxxxx the project xxxxxxx xxxxxxx qualify xxxxxxx How do xxxxxxx respond?

(The xxxxxxx response xxxxxxx xxxxxxx short. It's xxxxxxx noting that xxxxxxx kind of xxxxxxx happens all xxxxxxx time in xxxxxxx Marketing and xxxxxxx xxxxxxx often xxxxxxx carried away xxxxxxx "neat" projects xxxxxxx don't xxxxxxx xxxxxxx financially. The xxxxxxx has to xxxxxxx the bottom xxxxxxx and it's xxxxxxx unusual to xxxxxxx seen as xxxxxxx xxxxxxx blanket xxxxxxx wants to xxxxxxx the others' xxxxxxx We xxxxxxx xxxxxxx the money xxxxxxx raised two xxxxxxx ago on xxxxxxx project, because xxxxxxx already been xxxxxxx We have xxxxxxx xxxxxxx new xxxxxxx for the xxxxxxx project. You're xxxxxxx in xxxxxxx xxxxxxx cost of xxxxxxx existing capital xxxxxxx a much xxxxxxx figure than xxxxxxx one I'm xxxxxxx But that xxxxxxx xxxxxxx irrelevant. xxxxxxx important is xxxxxxx cost of xxxxxxx money xxxxxxx xxxxxxx raising in xxxxxxx near future xxxxxxx fund this xxxxxxx That cost xxxxxxx reflected by xxxxxxx market rates, xxxxxxx xxxxxxx much xxxxxxx than our xxxxxxx rates.

3. The xxxxxxx department xxxxxxx xxxxxxx Inc. wants xxxxxxx buy a xxxxxxx state-of-the-art computer. xxxxxxx proposed machine xxxxxxx faster than xxxxxxx one now xxxxxxx xxxxxxx but xxxxxxx the extra xxxxxxx is worth xxxxxxx expense xxxxxxx xxxxxxx given the xxxxxxx of the xxxxxxx applications. The xxxxxxx Engineer (who xxxxxxx an MBA xxxxxxx a reasonable xxxxxxx xxxxxxx financial xxxxxxx has put xxxxxxx an enormously xxxxxxx capital xxxxxxx xxxxxxx for the xxxxxxx of the xxxxxxx machine. The xxxxxxx concludes that xxxxxxx a great xxxxxxx You're a xxxxxxx xxxxxxx for xxxxxxx firm, and xxxxxxx been assigned xxxxxxx review xxxxxxx xxxxxxx proposal. Your xxxxxxx has highlighted xxxxxxx problems. First, xxxxxxx cost savings xxxxxxx as a xxxxxxx of using xxxxxxx xxxxxxx machine xxxxxxx rather optimistic. xxxxxxx the analysis xxxxxxx an xxxxxxx xxxxxxx cost of xxxxxxx With respect xxxxxxx the second xxxxxxx the engineering xxxxxxx contains the xxxxxxx exhibit documenting xxxxxxx xxxxxxx of xxxxxxx cost of xxxxxxx used:

**Digitech's xxxxxxx xxxxxxx is 60% xxxxxxx and 40% xxxxxxx align="center"> **

**The xxxxxxx is offering xxxxxxx at 8% xxxxxxx a sales xxxxxxx xxxxxxx align="center"> Cost xxxxxxx capital = xxxxxxx ´ .6 xxxxxxx 4.8%**

**-****T) xxxxxxx 4.8%(.6) = xxxxxxx align="center"> **

xxxxxxx checked the xxxxxxx and found xxxxxxx xxxxxxx bonds xxxxxxx currently selling xxxxxxx yield 14% xxxxxxx the xxxxxxx xxxxxxx returning about xxxxxxx How would xxxxxxx proceed? That xxxxxxx explain the xxxxxxx engineer's error(s) xxxxxxx indicate the xxxxxxx xxxxxxx The xxxxxxx engineer has xxxxxxx forgotten his xxxxxxx The xxxxxxx xxxxxxx is using xxxxxxx cost of xxxxxxx financing to xxxxxxx a project xxxxxxx of the xxxxxxx of capital. xxxxxxx xxxxxxx an xxxxxxx procedure that xxxxxxx to bad xxxxxxx in xxxxxxx xxxxxxx run although xxxxxxx will virtually xxxxxxx acceptance of xxxxxxx current project. xxxxxxx "A Potential xxxxxxx - Handling xxxxxxx xxxxxxx Projects.") xxxxxxx top of xxxxxxx the proposal xxxxxxx *part xxxxxxx xxxxxxx weighted average xxxxxxx to further xxxxxxx the interest xxxxxxx used to xxxxxxx the project.*

xxxxxxx coupled with xxxxxxx xxxxxxx cash xxxxxxx estimates makes xxxxxxx think that xxxxxxx computer xxxxxxx xxxxxxx something the xxxxxxx want but xxxxxxx really support xxxxxxx That means xxxxxxx likely to xxxxxxx an emotional xxxxxxx xxxxxxx probably xxxxxxx if you xxxxxxx go to xxxxxxx chief xxxxxxx xxxxxxx to challenge xxxxxxx proposal. Take xxxxxxx findings to xxxxxxx CFO and xxxxxxx her approach xxxxxxx chief engineer xxxxxxx xxxxxxx and xxxxxxx the matter xxxxxxx This situation xxxxxxx something xxxxxxx xxxxxxx common. A xxxxxxx is presented xxxxxxx so much xxxxxxx information that xxxxxxx difficult to xxxxxxx the errors xxxxxxx xxxxxxx assumptions xxxxxxx in the xxxxxxx Whitefish Inc. xxxxxxx a xxxxxxx xxxxxxx 15 fishing xxxxxxx in the xxxxxxx Atlantic Ocean. xxxxxxx has been xxxxxxx in the xxxxxxx few years, xxxxxxx xxxxxxx the xxxxxxx for product, xxxxxxx the firm xxxxxxx sell xxxxxxx xxxxxxx fish it xxxxxxx catch. Charlie xxxxxxx the vice xxxxxxx for operations, xxxxxxx worked up xxxxxxx capital budgeting xxxxxxx xxxxxxx the xxxxxxx of new xxxxxxx Each boat xxxxxxx viewed xxxxxxx xxxxxxx individual project xxxxxxx to the xxxxxxx and shows xxxxxxx IRR of xxxxxxx The firm's xxxxxxx of capital xxxxxxx xxxxxxx correctly xxxxxxx at 14% xxxxxxx the retained xxxxxxx break xxxxxxx xxxxxxx after that xxxxxxx Charlie argues xxxxxxx the capital xxxxxxx figures show xxxxxxx the firm xxxxxxx acquire as xxxxxxx xxxxxxx boats xxxxxxx it possibly xxxxxxx financing them xxxxxxx whatever xxxxxxx xxxxxxx finds available. xxxxxxx are Whitefish's xxxxxxx Support or xxxxxxx Charlie's position. xxxxxxx should the xxxxxxx number of xxxxxxx xxxxxxx be xxxxxxx Does acquiring xxxxxxx large number xxxxxxx new xxxxxxx xxxxxxx any problems xxxxxxx risks that xxxxxxx immediately apparent xxxxxxx the financial xxxxxxx Although the xxxxxxx is 15% xxxxxxx xxxxxxx retained xxxxxxx break, it xxxxxxx remain at xxxxxxx level xxxxxxx xxxxxxx more boats xxxxxxx acquired with xxxxxxx financing, the xxxxxxx of capital xxxxxxx rise and xxxxxxx exceed 22%. xxxxxxx xxxxxxx level xxxxxxx investment in xxxxxxx boats should xxxxxxx determined xxxxxxx xxxxxxx how the xxxxxxx will behave, xxxxxxx estimating where xxxxxxx will exceed xxxxxxx Charlie's estimate xxxxxxx based on xxxxxxx xxxxxxx and xxxxxxx conditions. If xxxxxxx conditions aren't xxxxxxx buying xxxxxxx xxxxxxx number of xxxxxxx boats could xxxxxxx the firm's xxxxxxx substantially.

**PROBLEMS**

**WACC Calculations: xxxxxxx 13-1 (page xxxxxxx Blazingame Inc.'s xxxxxxx xxxxxxx have xxxxxxx following market xxxxxxx Debt xxxxxxx Preferred xxxxxxx xxxxxxx $17,500,000**

Common xxxxxxx $48,350,000

Calculate xxxxxxx firm's capital xxxxxxx and show xxxxxxx weights that xxxxxxx be used xxxxxxx xxxxxxx weighted xxxxxxx cost of xxxxxxx (WACC) computation.

**SOLUTION:**

xxxxxxx __Weights__

xxxxxxx xxxxxxx $35,180 xxxxxxx Preferred Stock xxxxxxx $17,500 xxxxxxx Common Equity xxxxxxx __$48,350__ xxxxxxx $101,030 xxxxxxx xxxxxxx Aztec xxxxxxx has the xxxxxxx capital components xxxxxxx costs. xxxxxxx xxxxxxx WACC.

__Component__ __Value__ xxxxxxx $23,625 xxxxxxx 12.0%

Preferred Stock xxxxxxx $ 4,350 xxxxxxx 13.5%

Common Equity xxxxxxx $52,275 xxxxxxx xxxxxxx __Weights__ xxxxxxx __Factors__

Debt xxxxxxx .294 xxxxxxx 12.0% xxxxxxx xxxxxxx $ xxxxxxx .054 xxxxxxx 13.5% .73

Common xxxxxxx __$52,275__ xxxxxxx __.652__* xxxxxxx __12.52__

$80,250 xxxxxxx xxxxxxx 16.78

xxxxxxx Use WACC xxxxxxx 16.8%

*Rounding xxxxxxx causes xxxxxxx xxxxxxx to sum xxxxxxx a figure xxxxxxx different from xxxxxxx When that xxxxxxx we generally xxxxxxx one figure xxxxxxx xxxxxxx way xxxxxxx show weights xxxxxxx add to xxxxxxx 1.000.

xxxxxxx Stock $15,000,000

xxxxxxx xxxxxxx Excess $15,000,000

Calculate xxxxxxx capital structure xxxxxxx on book xxxxxxx xxxxxxx style="margin-left:36.0pt;">**SOLUTION** xxxxxxx style="margin-left:36.0pt;"> %

xxxxxxx xxxxxxx 15.0 8.7

92.5 xxxxxxx style="margin-left:36.0pt;"> Total xxxxxxx 100.0

**Market Value xxxxxxx Capital Structure: xxxxxxx xxxxxxx (page xxxxxxx style="margin-left:36.0pt;">4. Referring xxxxxxx Willerton Industries xxxxxxx the xxxxxxx xxxxxxx the company’s xxxxxxx term debt xxxxxxx comprised of xxxxxxx $1,000 face xxxxxxx bonds issued xxxxxxx years ago xxxxxxx xxxxxxx 8% xxxxxxx rate. The xxxxxxx are now xxxxxxx to xxxxxxx xxxxxxx Willerton’s preferred xxxxxxx from a xxxxxxx issue of xxxxxxx par value, xxxxxxx preferred stock xxxxxxx is now xxxxxxx xxxxxxx yield xxxxxxx Willerton has xxxxxxx million shares xxxxxxx common xxxxxxx xxxxxxx at a xxxxxxx market price xxxxxxx $31. Calculate xxxxxxx market value xxxxxxx capital structure.**

**SOLUTION:**

a. xxxxxxx xxxxxxx of xxxxxxx style="margin-left:36.0pt;"> n xxxxxxx 13 x xxxxxxx = xxxxxxx xxxxxxx FV = xxxxxxx style="margin-left:36.0pt;"> I/Y xxxxxxx 6/2 = xxxxxxx style="margin-left:36.0pt;"> PMT xxxxxxx 1,000 x xxxxxxx = 40

__Market xxxxxxx of xxxxxxx xxxxxxx style="margin-left:36.0pt;"> Number xxxxxxx preferred shares xxxxxxx previous problem__

$9/.08 xxxxxxx $112.50

__ Market xxxxxxx %__

xxxxxxx $1,178.77 xxxxxxx xxxxxxx $76,620,050 35.2

xxxxxxx $31 x xxxxxxx __124,000,000__ __57.0__

5. xxxxxxx referring to xxxxxxx of xxxxxxx xxxxxxx previous problems, xxxxxxx the firm’s xxxxxxx of retained xxxxxxx is 11% xxxxxxx its marginal xxxxxxx rate is xxxxxxx xxxxxxx its xxxxxxx using its xxxxxxx value based xxxxxxx structure xxxxxxx xxxxxxx costs. Make xxxxxxx same calculation xxxxxxx the market xxxxxxx based capital xxxxxxx How significant xxxxxxx the difference?

__Book Value__

__ Preferred xxxxxxx x 8% xxxxxxx style="margin-left:36.0pt;"> Equity xxxxxxx x 11% xxxxxxx style="margin-left:36.0pt;"> WACC xxxxxxx xxxxxxx style="margin-left:36.0pt;"> xxxxxxx Value__

xxxxxxx .352 x xxxxxxx x xxxxxxx xxxxxxx .4) 1.27

6.27

6. xxxxxxx relatively young xxxxxxx has capital xxxxxxx valued at xxxxxxx xxxxxxx market xxxxxxx market component xxxxxxx as follows. xxxxxxx new xxxxxxx xxxxxxx been issued xxxxxxx the firm xxxxxxx originally capitalized.

xxxxxxx Market

__Component__ xxxxxxx __Market __ xxxxxxx __ Cost__

Debt xxxxxxx xxxxxxx xxxxxxx 8.5%

Preferred xxxxxxx $10,650 xxxxxxx $10,000 xxxxxxx xxxxxxx Equity xxxxxxx $32,000 xxxxxxx 25.3%

a. Calculate xxxxxxx firm's capital xxxxxxx and WACCs xxxxxxx on both xxxxxxx xxxxxxx market xxxxxxx and compare xxxxxxx two.

b. What xxxxxxx to xxxxxxx xxxxxxx to interest xxxxxxx since the xxxxxxx was started?

c. xxxxxxx the firm xxxxxxx to be xxxxxxx Why?

d. What xxxxxxx xxxxxxx the xxxxxxx of using xxxxxxx WACC based xxxxxxx book xxxxxxx xxxxxxx to market xxxxxxx In other xxxxxxx what kinds xxxxxxx mistakes might xxxxxxx make by xxxxxxx the book xxxxxxx xxxxxxx xxxxxxx __Market xxxxxxx Book xxxxxxx xxxxxxx xxxxxxx Market Book__

Debt xxxxxxx $42,830 .359 xxxxxxx $40,000 .488 xxxxxxx 8.5% xxxxxxx 4.15

Preferred Stock xxxxxxx $10,650 .090 xxxxxxx xxxxxxx .122 xxxxxxx 10.6% xxxxxxx 1.29

Common Equity xxxxxxx __$65,740__ xxxxxxx xxxxxxx __$32,000__ __.390 xxxxxxx 25.3% 13.94 xxxxxxx 9.87__

xxxxxxx 1.000 xxxxxxx 1.000 xxxxxxx 15.31

Use xxxxxxx xxxxxxx 17.9% xxxxxxx The overall xxxxxxx of capital xxxxxxx risen xxxxxxx xxxxxxx the net xxxxxxx of a xxxxxxx increase in xxxxxxx value of xxxxxxx firm's equity. xxxxxxx throws more xxxxxxx xxxxxxx high xxxxxxx into the xxxxxxx Interest rates xxxxxxx to xxxxxxx xxxxxxx since the xxxxxxx values of xxxxxxx and preferred xxxxxxx their original xxxxxxx The firm xxxxxxx to be xxxxxxx xxxxxxx of xxxxxxx substantial increase xxxxxxx the value xxxxxxx equity. xxxxxxx xxxxxxx be due xxxxxxx an increase xxxxxxx stock price xxxxxxx a rapid xxxxxxx of retained xxxxxxx or a xxxxxxx xxxxxxx both.

d. xxxxxxx the book xxxxxxx WACC might xxxxxxx to xxxxxxx xxxxxxx that wouldn't xxxxxxx the expectations xxxxxxx have for xxxxxxx company's return.

7. xxxxxxx Five years xxxxxxx Hemingway Inc. xxxxxxx xxxxxxx thirty-year xxxxxxx with par xxxxxxx of $1,000 xxxxxxx a xxxxxxx xxxxxxx of 8%. xxxxxxx bonds are xxxxxxx selling to xxxxxxx 5%. The xxxxxxx also has xxxxxxx shares of xxxxxxx xxxxxxx outstanding xxxxxxx pay a xxxxxxx of $6.50 xxxxxxx share. xxxxxxx xxxxxxx currently selling xxxxxxx yield 10%. xxxxxxx common stock xxxxxxx selling at xxxxxxx and 200,000 xxxxxxx are outstanding. xxxxxxx xxxxxxx market xxxxxxx based capital xxxxxxx The current xxxxxxx of xxxxxxx xxxxxxx is

xxxxxxx = PMT[PVFA_{k,n}] xxxxxxx FV[PVF_{k,n}]

xxxxxxx = $40[PVFA_{2.5,50}] xxxxxxx $1,000[PVF_{2.5,50}]

xxxxxxx = $40[28.3623] xxxxxxx xxxxxxx style="margin-left:36.0pt;"> xxxxxxx = $1,134.49 xxxxxxx $290.90

xxxxxxx = xxxxxxx xxxxxxx value of xxxxxxx bonds is

xxxxxxx ´ 6,000 xxxxxxx $8,552,340

The preferred xxxxxxx shares are xxxxxxx worth

P_{P} xxxxxxx xxxxxxx / xxxxxxx = $65.00

In xxxxxxx they’re worth

xxxxxxx ´ xxxxxxx xxxxxxx $975,000

The xxxxxxx value of xxxxxxx stock is xxxxxxx $21.00 ´ xxxxxxx = $4,200,000

xxxxxxx capital is xxxxxxx xxxxxxx of xxxxxxx figures and xxxxxxx structure is xxxxxxx component xxxxxxx xxxxxxx the total xxxxxxx as a xxxxxxx __Component__ __ Value xxxxxxx Capital xxxxxxx Debt xxxxxxx 8,552,340 xxxxxxx xxxxxxx Preferred xxxxxxx 975,000 xxxxxxx Equity xxxxxxx 4,200,000 xxxxxxx xxxxxxx 30.6%__

xxxxxxx Capital $13,727,340 xxxxxxx The xxxxxxx Company has xxxxxxx shares of xxxxxxx stock outstanding xxxxxxx xxxxxxx currently xxxxxxx at $28.63. xxxxxxx has 4,530 xxxxxxx outstanding xxxxxxx xxxxxxx mature for xxxxxxx years. They xxxxxxx issued at xxxxxxx par value xxxxxxx $1,000 paying xxxxxxx coupon rate xxxxxxx xxxxxxx Comparable xxxxxxx now yield xxxxxxx Wall’s $100 xxxxxxx value xxxxxxx xxxxxxx was issued xxxxxxx 8% and xxxxxxx now yielding xxxxxxx 7,500 shares xxxxxxx outstanding. Develop xxxxxxx market value xxxxxxx xxxxxxx structure.

**SOLUTION**:

xxxxxxx current price xxxxxxx the bonds xxxxxxx style="margin-left:36.0pt;"> xxxxxxx xxxxxxx PMT[PVFA_{k,n}] + xxxxxxx style="margin-left:36.0pt;"> P_{B} xxxxxxx $30[PVFA_{4.5,40}] + xxxxxxx style="margin-left:36.0pt;"> P_{B} xxxxxxx $30[18.4016] + xxxxxxx style="margin-left:36.0pt;"> P_{B} xxxxxxx xxxxxxx + xxxxxxx style="margin-left:36.0pt;"> P_{B} xxxxxxx $723.95

The market xxxxxxx of xxxxxxx xxxxxxx is

$723.95 xxxxxxx 4,530 = xxxxxxx preferred stock xxxxxxx pay a xxxxxxx of ($100x.08=) xxxxxxx and are xxxxxxx xxxxxxx P_{P} xxxxxxx $8.00 / xxxxxxx = $72.73

In xxxxxxx they’re xxxxxxx xxxxxxx ´ 7,500 xxxxxxx $545,475

The xxxxxxx value of xxxxxxx common stock xxxxxxx $28.63 ´ xxxxxxx = $4,079,775

xxxxxxx xxxxxxx is xxxxxxx sum of xxxxxxx figures and xxxxxxx structure xxxxxxx xxxxxxx component divided xxxxxxx the total xxxxxxx as a xxxxxxx __Component__ __ Value xxxxxxx Capital Structure__

xxxxxxx Debt $3,279,494 xxxxxxx xxxxxxx xxxxxxx 545,475 xxxxxxx 6.9%

xxxxxxx __ xxxxxxx xxxxxxx 51.6%__

xxxxxxx Capital $7,904,744 xxxxxxx The market xxxxxxx of Albertson xxxxxxx common stock xxxxxxx $5.50, and xxxxxxx xxxxxxx are xxxxxxx The firm's xxxxxxx show common xxxxxxx accounts xxxxxxx xxxxxxx There are xxxxxxx preferred shares xxxxxxx that originally xxxxxxx for their xxxxxxx value of xxxxxxx pay an xxxxxxx xxxxxxx of xxxxxxx and are xxxxxxx selling to xxxxxxx an xxxxxxx xxxxxxx Also, 200 xxxxxxx outstanding that xxxxxxx issued five xxxxxxx ago at xxxxxxx $1,000 face xxxxxxx for 30-year xxxxxxx xxxxxxx a xxxxxxx rate of xxxxxxx and are xxxxxxx selling xxxxxxx xxxxxxx 10%. Develop xxxxxxx capital structure xxxxxxx on both xxxxxxx and market xxxxxxx