1
Q
Cooperate Issuers
Sole Proprietorship
A
owned and operated by an individual, taxed as person income; owner has unlimited liability.
2
Q
Partnership
A
A business owned by multiple owners
3
Q
General Partnership
A
Two or more general partners own and operate the business and are liable for claims
4
Q
Limited Partnership
A
General Partners manage the business and are personally liable while limited partners are only liable for invested amount
5
Q
Limited Liability Partnership
A
Is a special case composed entirely of LP
6
Q
Limited Companies
A
Benefits are greater access to financing and potential for growth
7
Q
Private Limited Company
A
Known as LLC in the US all owners have limited liability, with company usually professionally managed, and ownership, and ownership is divided into private shares
8
Q
Private Limited Company (Corporation)
A
legal identify separate from owners, profit taxed, also limited owner liability, but no restriction on number of owners; must suitable for going IPO
9
Q
Summary of Business Structures
A
10
Q
Key features of Corporations
A
-The most important features of corporations include the following
–Legal identity, that is separate and distinct from its owners
–Owner-manager separation, between shareholders and managers/board
–Owner/shareholder liability, which is limited but shared
–External financing, with access to both debt and equity financing
–Taxation double
11
Q
Public and Private Corporations
A
Benefits of public listing
-Allows transfer of ownership
-Liquidity
-Regulatory transparency and disclose
-Price transparency
Benefits of Price Listing
-Controlling owners/managers are accountable to fewer shareholders
-potential for investors to earn higher returns
-fewer disclosure requirements
12
Q
Going Private to Public Corp
A
1) IPO
2) Direct listings of shares
3) Acquisition by public company
-Special purpose acquisition company (SAPC) a company set up purely to purchase a private company to turn it into a public one
13
Q
Going public to private Corp
A
-Investors buying all the shares of a corp and delisting
-allows for restructuring and greater control over the corp
-more frequent in developed markets
-example is a leveraged buyout
14
Q
Financial Claims of Lenders and Shareholders
Debtholders
A
Debtholders (lenders) provide finite capital
-legal claim to the principal and interest
-higher priority of claims than equity holders
-Upside is limited to full repayment; no decision-making power
15
Q
Financial Claims of Lenders and Shareholders
Equity Investors
A
Equity Investors (shareholders/owners) provide permeant capital. they have a residual claim to assets after all other claims have been paid
16
Q
Debt vs equity risk and return
A
17
Q
Shareholder Theory
A
focus on interests of the company’s owners; other entities are considered, but only to the extent that they impact sharevalue
18
Q
Stakeholder Theory
A
Consider all stakeholder interests. Focus on managing potential conflicts among interests of stakeholder groups. ESG is often a consideration
19
Q
Cooperate Stakeholder and Governance
A
20
Q
ESG Considerations
A
21
Q
Evaluating ESG Risks and Benefits
A
22
Q
Principal-Agent-Relationship Graph
A
23
Q
Principal-Agent-Relationship
A
24
Q
Principal-Agent-Relationship
Types of Agency Cost
A
25
Controlling and Minority Shareholders
26
Corporate Governance Mechanisms
27
Corporate Governance Mechanisms
Corporate Reporting and Transparency
28
Corporate Governance Mechanisms
Shareholder Mechanisms
1) Annual General Meeting (AGM)
2)Extraordinary general meetings (EGM)
3)Proxy Voting
4) Shareholder Activism
-examples Carl Icahn
29
Corporate Governance Mechanisms
Creditor Mechanisms
-Bond indentures and covenants: legal contract between company and creditors
-Creditor Committees: often established after bankruptcy filling, bondholders may also form an ad hoc committee
30
Corporate Governance Mechanisms
Bond/Management Mechanisms
-Bonds often delegate functions to various committees
1) Audit
2) Nomitting/governance
3) Compensation/remuneration
4) Other committees (Risk, Investment
31
Corporate Governance Mechanisms
Employee Mechanisms
-Labor Laws, employment contracts, right to form unions
-employee stock ownership plans (ESOPs) to align intrests
32
Corporate Governance Mechanisms
Customer and Supplier Mechanisms
-Contracts with suppliers
-Social media to communicate with and influence shareholders
33
Corporate Governance Mechanisms
Government Mechanisms
-Laws, and regulation, including protecting/enforcing property and contract rights
-Corporate governance codes
--Interestingly the US does not have national corporate governance codes though it does have national securities laws
34
Risks and Benefits of Corporate Governance
-Strong Corporate governance will benefit companies while weak governance may decrease company value. Risks and benefits include the following:
35
Cash Conversion Cycle
36
Shortening the Cash Conversion Cycle 3 Methods
1) Reduce DOH
2) Reduce DSO
3) Reduce DPO
37
Shortening the Cash Conversion Cycle
Reduce DOH
Reduce DOH: Cancelling products with a low demand, main "just-in-time" inventory levels, analyze data carefully to refine customer demand forecasts and stocking levels
38
Shortening the Cash Conversion Cycle
Reduce DSO
Reduce DSO: Provide early payment discounts, encourage cash, debit card, and credit card payments, mandate up front deposits; charge late charges; tighten credit standards
39
Shortening the Cash Conversion Cycle
Reduce DPO
Reduce DPO: Negotiating supplier contracts for longer terms in exchange for larger volumes
40
Working Capital
41
Liquidity
-Liquidity is its nearness (within 12 months) to cash or settlement; assets or liabilities are presented on balance sheet in descending order of liquidity
42
Current Asset
Cash is most liquid asset while inventories are usually the least liquid current asset
43
Current Liquidity
Accrued Payroll (to be paid in a few days) is more liquid than short-term debt (eg. not required to pay till perhaps 6 months from now)
44
Primary Sources of Liquidity
-Cash and marketable securities on hand
1) Borrowing: includes banks and suppliers trade credit: temporary liquidity sources that need to eventually be repaid
2)Cash flow from the business: the most important long term liquidity source, monitored using the statement of cash flow
45
Calculating Cash Flow
46
Secondary Sources of Liquidity
1) Suspending or discounting dividends
2) differing or lowering capital spending
3) issuing equity
4) renegoting contract terms
5) Selling assets
6) filing for bankruptcy protection
47
Pull on Liquidity (Accerlating Cash Flows)
1) Making payments early
2) Lowered credit terms
3) limits on short lines of credit
4) weak liquidity positions
48
Drag on Liquidity (Lagging Cash Flows)
1) Uncollected receivables
2) obsolete inventory
3) borrowing constraints
49
Liquidity Ratios
50
Working Capital Management Approach (Conservative)
51
Working Capital Management Approach (Aggressive)
52
Working Capital Management Approach (Moderate)
53
Cost of Capital
-A company's cost of capital (required rate of return includes)
1) Cost of Debt Rd
-Debt is less risky as it is a priority fixed claim and often secured with collateral so Rd is lower
-Starting point for estimating Rd is existing or recent borrowing rates of peer companies
2) Cost of Equity (Re)
-Equity is riskier as its a permeant residual claim so Re is higher
54
WACC
55
WACC Financing Required
56
Corporate Life Cycle
Stages
1) Early Stage or Start up
2) Growth
3) Mature
57
Corporate Life Cycle
Early Stage or Start up
Early Stage or Start up: zero or low sales; negative free cash flow; high business risk, so financing is largely done from founders, employees and venture capitalists. Possible financing through leases and convertible debt
58
Corporate Life Cycle
Growth Stage
Growth Stage: Greater product demand and revenue growth, so medium business risk and increasing free cash flow; some use of secured debt, but still mainly equity financing
59
Corporate Life Cycle
Mature Stage
Mature: Revenue growth slows but is stable, so low business risk and relatively high and consistent free cash flow; more use of secured debt that is often cheaper than equity
60
Corporate Life Cycle Grid
61
Top-Down Factors Affecting Cost of Capital
Financial Market Conditions
Financial Market Conditions
-Cost of debt includes a spread to cover issuer - specific risk
-Increases in interest rate and /or recession/ default risk increase cost of debt
-Higher stock prices decrease cost of equity and encourage equity issuances
62
Top-Down Factors Affecting Cost of Capital
Industry Conditions
Industry Conditions
-The nature of the products or services sold by the company sells (low oil prices are bad for oil producers and increase cost of capital but good for airliners which decreases cost of capital
63
Issuer-Specific Factors Affecting Cost of Capital
1) Sales Risk
2) Profitability Risks (operating leverage)
3) Financial leverage and interest coverage
4) Collateral/ type of asset owned
64
Modigliani-Miller Propositions
65
Capital Structure Irrelevance
MM Porp 1 without Taxes: Changing the capital structure does not affect firm's value
-Value of levered company (VL)= value of unlevered company (Vu)
-Company value is determined solely on expected future cash flows
-Total cash flows to debtholders and equity holders are the same for leveraged and unleveraged firms
-Investors can choose the level of leverage by borrowing and lending it at the risk-free rate
66
Cost of Capital MM2
67
MM with no taxes graph
68
Static Trade-Off Theory
69
Static Trade-Off Theory Graph
70
Target Capital Structure
71
Pecking Order Theory
72
Agency Cost
-Using more debt in the capital structure could result in avoiding the agency costs of equity
-Free cash flow hypothesis suggests that the more constrained a company is with debt, the more likely managers will spend funds wisely to meet periodic interest and principal payments
73
Business Model Features
74
Pricing and Revenue Models
-Pricing establishes how much to charge customers for products or services
-Price Discrimination maximizes profit by setting different prices for different customers or identifiable groups of customers
1) Tiered Pricing (Volume)
2) Dynamantic Pricing (off peak/peak)
3) Value-based pricing
4) Auction Pricing
75
Pricing for Multiple Products
-Firms often sell multiple or complex products with different pricing schemes
1) Bundling This is combining multiple products that customers often buy together. It is effective when marketing costs are high (eg. furnishing apartments)
2) Razor, razorblade pricing: This is selling low-priced equipment with high margin add ons/follow up purchases (razors, ink)
3) Add On Pricing: This is selling optional services or add ons with high margins after the initial purchase is made (video games)
76
Other Pricing Models
Penetration Pricing (discount)
Freemium Pricing (basic vs premium)
Hidden revenue (ads)
Subscription Model (software)
Licensing and leasing and franchising
77
Value Proposition
-A firm's value proposition refers to how customers will value the attributes of a product or service, leading them to purchase it
-the value chain refers to how the firm executes its value proposition (ie how it creates value)
-by contrast: the supply chain refers to the process involved in creating a product
78
A private company can become a public company through a:
special Acquistion company
79
effective tax rate on profits distributed as dividends
Corp Tax + dividend tax (1- Corp Tax)
80
Which of the following board structures is most likely to be preferred by a minority shareholder?
majority independent and full board election
81
A company decides to shut down a production plant rather than retrofit it to comply with new environmental regulations. This is best described as an example of:
Stranded assets
Stranded assets arise from obsolescence of existing assets that do not conform to new environmental standards.
82
Between which two of a company's stakeholder groups does information asymmetry most likely make monitoring more difficult?
managers and shareholders
83
The theory that deals with conflicts of interest between a company's owners and its creditors is most appropriately called:
stakeholder theory
84
Benefits of effective corporate governance and stakeholder management most likely include:
Reduced risk of default
85
Compared to its industry peers, a company with a shorter cash conversion cycle most likely:
accounts recieveable
86
A company receives an invoice of $150,000 for machine tools with terms of "1.5/15 net 40." The cost to the company of delaying payment of this receivable is most appropriately described as $2,250 for the use of:
$150,000(1 − 0.015) = $147,750 on day 15 (after the invoice date) or pay $150,000 on day 40—effectively gaining the use of
-$147,750 for 25 day
87
Which of the following actions is most likely to increase liquidity for a corporation?
selling inventory at a discount of 5%
88
Which of the following is least likely a primary source of liquidity?
delaying capital expenditures
89
Which of the following most likely represents conservative working capital management?
financing an increase in receivables by increasing long term borrowing
90
Which of the following is most likely a going concern project?
-Purchase a new model of a factory machine that will decrease unit production costs
-Going concern projects are those to maintain the business or to increase the efficiency of existing operations. The other two projects are business growth investments that increase the size of the company
91
In the capital allocation process, a post-audit is used to:
-improve cash flow forecasts and stimulate management to improve operations and bring results into line with forecasts
-A post-audit identifies what went right and what went wrong. It is used to improve forecasting and operations
92
A company is considering the purchase of a copier that costs $5,000. Assume a required rate of return of 10% and the following cash flow schedule:
Year 1: $3,000.
Year 2: $2,000.
Year 3: $2,000.
The project's NPV is closest to:
-+883
CF0 = –5,000; CF1 = 3,000; CF2 = 2,000; CF3 = 2,000; I / Y = 10; NPV = $883.
93
Which of the following statements concerning the principles underlying the capital allocation process is most accurate?
-Cash flows should include tax benefits of non-cash expense deductions
- Cash flows should be after-tax and include any tax savings from non-cash deductions (e.g., depreciation and amortization). While sunk costs should be ignored, the impact on other parts of the business (positive or negative) should be accounted for by adjusting cash flows. Accounting net income, which includes non-cash expenses, is irrelevant. Incremental cash flows are essential for making correct capital allocation decisions.
94
A manufacturer of clothes washing machines decides to add matching clothes dryers to its product line. In this case, it is most likely important in the project analysis to consider:
-positive impact on other parts of business
-It is quite possible that offering a matching dryer will increase sales of their washers because some consumers will prefer a matching set. The increased sales of their washers is a positive impact, and those incremental profits should be considered in the analysis. A negative impact on another part of the business would be a consideration if introducing dryers could be expected to decrease washer sales. Sunk costs should not be considered in project analysis.
95
An analyst is estimating the NPV of a project to introduce a new spicier version of its well-known barbeque sauce into its product line. A cost that should most likely be excluded from his analysis is:
-100k for a marketing survey to determine demand for a spicier sauce
-The cost of the marketing survey should not be included because it is a sunk cost; it will be incurred whether they decide to do the project or not. The decrease in sales of their current sauce if the spicier version is introduced (cannibalization) should be considered in the analysis. The cost of recipe development should be included because it will only be incurred if they decide to go ahead with the introduction of the new spicier sauce. (Module 24.2, LOS 24.c)
96
Albert Duffy, a project manager at Crane Plastics, is considering taking on a new capital project. When presenting the project, Duffy shows members of Crane's executive management team that, because the company has the ability to have employees work overtime, the project makes sense. The project Duffy is taking on would be best described as having a(n):
-flexibility option
-The project described has production flexibility regarding the level of production. Other flexibility options might be to produce a different product or to use different inputs at some future date. Including the value of real options can improve the NPV estimates for individual projects
97
A small group of investment professionals is looking to establish a partnership agreement that specifies two of them as general partners and the rest as limited partners. The most appropriate form of partnership is a:
limited partnership
98
Which of the following payments are contractual obligations of a corporation?
Interest and principal payments
99
According to the static trade-off theory:
there is an optimal proportion of debt that will maximize the value of the firm
100
Which of the following statements regarding Modigliani and Miller's Proposition II with taxes is most accurate?
-the value of the firm is maximized at the point where wacc is minimized
-The tax shield provided by debt causes the WACC to decrease as leverage increases. The value of the firm is maximized at the point where the WACC is minimized, which is 100% debt under the MM assumptions.
101
Binder Company describes itself as a direct sales business. In terms of its business model, this refers to Binder's:
channel stratergy
102
Which of the following steps is least likely to be a step in the capital allocation process?
-Arranging financing for capital projects.
-Arranging financing is not one of the administrative steps in the capital allocation process. The four administrative steps in the capital allocation process are:
Idea generation
Analyzing project proposals
Creating the firm-wide capital budget
Monitoring decisions and conducting a post-audit
103
Under the assumptions of Modigliani and Miller's Proposition I, the value of a firm:
is not affected by its capital structure.
According to Modigliani and Miller's Proposition I, under certain assumptions, including the absence of taxes and bankruptcy costs, the value of a firm is unaffected by its capital structure.
104
Under the static tradeoff theory, the optimal capital structure of a firm is at the point where the:
difference between the value of a levered firm and unlevered firm is at its maximum.
The optimal capital structure of a firm occurs at a point where the value of a levered firm is at its peak. Because the value of an unlevered firm is constant (there is no tax benefit from debt and no cost of financial distress), the point where the value of a levered firm is at its peak is also the point where the difference between the value of a levered firm and the value of an unlevered firm is at its maximum.
105
Following a significant and persistent increase in nickel prices, a mine operator decides to open a new nickel mine in Canada. Opening the mine is best characterized as:
Fundamental options are real options where the project (in this case, the nickel mine) itself is the option. The company has the flexibility to mine or not mine the product, in part based on the price of the product.
Expansion options give a company the right to make additional investments in future projects if the projects will create value.
Flexibility options give a company the right to increase or decrease the price of a product or production volumes in the future.
106
According to the static tradeoff theory of capital structures, the:
cost of equity is upward sloping.
The cost of equity is upward sloping, because as leverage increases, the cost of equity increases.
According to the static tradeoff theory, WACC initially decreases with additional debt financing, but then rises when the increase in the expected value of financial distress outweighs the tax benefits of additional debt. The tax shield (benefit), however, will increase as borrowing increases.
107
If the days of inventory on hand, days sales outstanding, and days payable outstanding all doubled, a positive cash conversion cycle (CCC) would:
double.
The CCC is calculated by adding the days of inventory on hand and the days sales outstanding, and subtracting the days payable outstanding. A doubling of all components of a positive CCC would double the value of the CCC.
In fact, the doubling of all components of the CCC would double the value of any CCC (even if negative), with the exception when the CCC is zero.
108
A supplier offers 4/30 net 90 terms. The bank interest rate is 6.5%. Which source of financing is the cheapest?
The EAR of supplier financing = (1 + 0.04 / 0.96)365/60 – 1 = 28.2%.
109
Which of the following companies' working capital management is most indicative of a moderate approach?
110
Removing the assumption of no taxes, but keeping all of Modigliani and Miller's other assumptions, which of the following would be the optimal capital structure for maximizing the value of a firm?
100% debt
If MM's other assumptions are maintained, removing the no tax assumption means that the value of the firm is maximized when the value of the tax shield is maximized, which occurs with a capital structure of 100% debt.
111
The cash conversion cycle (CCC) would most likely decrease if:
days of inventory on hand decreased.
The CCC measures the time it takes for a company to convert its investments in inventory and other resources into cash inflows from sales. The CCC is calculated by adding the days of inventory on hand and the days sales outstanding, and subtracting the days payable outstanding. The CCC would, therefore, decrease if either the days of inventory on hand or the days sales outstanding decreased, or if the days payable outstanding increased.
112
Which of the following types of capital investments are most likely to generate little to no revenue?
Regulatory projects.
113
An auto manufacturer recently introduced new technologies into its production of its popular pickup truck. The new technologies will allow the manufacturer to easily convert its production pickup trucks to electric vehicles in a few years. This choice is best characterized as a:
flexibility option.
A flexibility option gives the holder the right to make future operational decisions regarding price and production. Flexibility relates to overtime pay, input materials, prices charged, and the type of products produced—including, in this case, the choice to convert production to electric vehicles.
A timing option allows companies to make future decisions regarding timing of investments.
An expansion (growth) option gives companies the right to make additional investments in future projects if the projects will create value.
114
The CFO of Axis Manufacturing is evaluating the introduction of a new product. The costs of a recently completed marketing study for the new product and the possible increase in the sales of a related product made by Axis are best described (respectively) as:
sunk cost; externality.
The study is a sunk cost, and the possible increase in sales of a related product is an example of a positive externality.
115
If a calculated net present value is negative, the discount rate used is:
greater than the internal rate of return.
When NPV = 0, the discount rate used is equal to the IRR. If a discount rate is used that is higher than the IRR, the NPV will be negative. Conversely, if a discount rate is used that is lower than the IRR, the NPV will be positive.
116
cash conversion cycle
117
While conducting market research, an analyst observes that significant amounts of a company's sales are prepaid, while inventory levels are generally very low. The analyst should most appropriately conclude that the company has a:
118
Which of the following scenarios is most consistent with a conservative approach to working capital management?
A company funds its inventory needs using long-term debt.
Companies with a conservative approach to working capital management typically finance working capital needs using long-term financing, including both equity and debt issuances. For example, they tend to use long-term funds to pay for permanent working capital like inventory, salaries, and rent. These companies typically hold higher levels of short-term assets compared to long-term assets.
119
One of the basic principles of capital allocation is that:
decisions are based on cash flows.
Key principles of the capital allocation process are:
Decisions are based on cash flows, not accounting income.
Cash flows are based on opportunity costs.
The timing of cash flows is important.
Cash flows are analyzed on an after-tax basis.
Financing costs are reflected in the project's required rate of return.
120
A company's management recently decided to fund its inventory needs and rent expenses using long-term debt rather than short-term debt. The management's decision would most likely result in higher:
costs.
The management's decision to use more long-term financing to fund working capital (like inventory costs and rent expense) is indicative of a more conservative approach to working capital management. The conservative approach typically results in higher funding costs (long-term debt costs are higher than short-term) and lower profitability—and therefore, equity.
121
The executive management of Global Capital Advisors (GCA) is considering making a new acquisition that needs a significant amount of capital. Based on the pecking order theory, GCA's most appropriate financing decision is to use:
internal financing, because it is least likely to send a negative signal to investors.
122
The conclusion of Modigliani and Miller's capital structure model with taxes is that:
firms should be financed with all debt.
123
Buildup Design, Inc., expects a 20% reduction in its days payable outstanding from 50 to 40 days, while its days of inventory on hand and days sales outstanding would remain unchanged. What would be the most likely impact on the cash conversion cycle (CCC)?
The CCC would increase by 10 days.
The CCC is calculated by adding the days of inventory on hand and the days sales outstanding, and subtracting the days payable outstanding. A shorter days payable outstanding implies less generous credit terms by suppliers, where the company must pay its suppliers in a shorter time period. This would increase the CCC by 10 days.
124
A financial services company requires all new hires in senior management positions to sign noncompete agreements. The costs associated with these noncompete agreements are an example of:
bonding costs, a component of the net agency costs of equity.
125
A high cash conversion cycle suggests that a company's investment in working capital is:
too high.
126
Should a company accept a project that has an IRR of 14% and an NPV of $2.8 million if the cost of capital is 12%?
The project should be accepted on the basis of its positive NPV and its IRR, which exceeds the cost of capital.
127
A firm is planning a $25 million expansion project. The project will be financed with $10 million in debt and $15 million in equity stock (equal to the company's current capital structure). The before-tax required return on debt is 10% and 15% for equity. If the company's tax rate is 35%, what cost of capital should the firm use to determine the project's net present value?
11.6%.
Weight of equity = $15 million / ($10 million + $15 million) = 60%
Weight of debt = $10 million / ($10 million + $15 million) = 40%
WACC = 0.60(kCE) + 0.40(after-tax kD)
WACC = 0.60(0.15) + 0.40(0.10)(1 − 0.35) = 0.09 + 0.026 = 0.116 or 11.6%
128
An analyst covering the reinsurance sector observes that the capital structure of three of the covered firms recently deviated from their targets. That analyst should be most concerned with:
Firm B, whose debt weight increased relative to target following the issuance of new debt.
The analyst should be most concerned with Firm B because by issuing new debt, the management has intentionally altered the capital structure weights. Unintentional or unavoidable deviations from a firm's target capital structure would be less cause for concern; these include deviations caused by fluctuations in the market value of equity as well as minimum lot size requirements when issuing new equity, which may make it difficult to adhere to precise capital structure weights.
129
A real option can:
never have a negative value.
130
Which of the following examples best represents a flexibility option?
In one year, a company can increase the price of its product by up to 30% if demand rises.
A flexibility option gives the holder the right to make future operational decisions regarding price and production. Flexibility relates to overtime pay, input materials, prices charged, and the type of products produced.
The answer option referencing a $500 million investment is an example of an expansion (growth) option, which gives a company the right to make additional investments in future projects if the projects will create value.
The answer option referencing a company ceasing operating a factory is an example of an abandonment option, which gives a company the right to abandon a project in the future if the NPV of the project is negative.
131
current ratio
current assets / current liabilities
132
quick ratio
current assets – inventories) / current liabilities
133
The quick ratio is considered a more conservative measure of liquidity than the current ratio because the quick ratio excludes:
The quick ratio is usually defined as (current assets – inventories) / current liabilities. The quick ratio excludes inventories from current assets because inventories are not necessarily liquid. It is a more restrictive measure of liquidity than the current ratio, which equals current assets / current liabilities. Current assets that remain in the numerator of the quick ratio include cash and cash equivalents, accounts receivable, and short-term marketable securities.
134
Which of the following scenarios is most consistent with an aggressive approach to working capital management?
Companies with an aggressive approach to working capital management favor using cheaper, short-term financing to fund their working capital needs.
135
Elenore Rice, CFA, is asked to determine the appropriate weighted average cost of capital for Samson Brick Company. Rice is provided with the following data:
Debt outstanding, market value $10 million
Common stock outstanding, market value $30 million
Marginal tax rate 40%
Cost of common equity 12%
Cost of debt 8%
Samson has no preferred stock. Assuming Samson's ratios reflect the firm's target capital structure, Samson's weighted average cost of capital is closest to:
The capital structure ratios are:
Debt to total capital = $10 / ($10 + $30) = 25%
Equity to total capital = $30 / ($10 + $30) = 75%
The formula for the WACC (if no preferred stock) is:
WACC = wdkd(1 – t) + wcekce
where wd is the percentage of operations financed by debt, wce is the percentage of operations financed by equity, t is the marginal tax rate, kd is the before-tax cost of debt, and kce is the cost of common equity.
WACC = 0.25(0.08)(0.60) + 0.75(0.12) = 0.102 = 10.2%.
136
A company with a moderate approach to working capital management would most likely fund:
permanent current assets using long-term funds, and fund seasonal current assets using short-term funds.
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