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Sheet1
| Unit | ||||||||||||||||||
| Five Steps | ||||||||||||||||||
| My work shows Debt at 7.5% and Tax Rate at 40%, the assignment numbers are different | ||||||||||||||||||
| Bankers and Investors – expect to be paid : | Portion of Capital Attained (Weight) | Stated Cost of Capital or Debt | Step 3 After-tax Cost | Apply Weights to Cost of Capital | ||||||||||||||
| Bankers | Interest Expense | 0.360 | 0.075 | Step 4 | ||||||||||||||
| Preferred Stock Dividend – Yield | 0.140 | 0.070 | 0.0700 | Step 1 | ||||||||||||||
| (Retained Earnings)Common~ Dividend – Yield | 0.500 | 0.118 | 0.1180 | Step 2 | ||||||||||||||
| 100% | Step 5 | |||||||||||||||||
| STEP 3 | ||||||||||||||||||
| I Borrow | I sell Stock | |||||||||||||||||
| Income | $ 1,200 | |||||||||||||||||
| Operating Expenses | $ 200 | |||||||||||||||||
| Operating Income | $ 1,000 | $ – 0 | ||||||||||||||||
| Taxable Income | $ 800 | |||||||||||||||||
| Apply a 40 % Tax Expense | $ 320 | $ 400 | ||||||||||||||||
| Mail your check to the IRS | Cash Out | |||||||||||||||||
| Step 3: Calculate the TRUE After tax cost of debt, Stated Cost x (1 – tax rate) of | Step 3: I saved $80 in taxes because I borrowed and paid interest expense | |||||||||||||||||
| .075(1-.40) | After Tax Cost 4.5% | |||||||||||||||||
| The true debt expense is smaller because it made your taxable income lower | ||||||||||||||||||
| Step 3 will be a separate slide |
There is a second part to the problem —
You are a consultant to Pillbriar Company. Pillbriar’s target capital structure is 36% debt, 14% preferred, and 50% common equity. The interest rate on new debt is 7.5%, the yield on the preferred is 7.00%, the common stock ( we say Common Stock) is 11.75%, and the tax rate is 40%. What is Pillbriar’s WACC?
What are three methods for estimating the cost of common stock from retained earnings? Which of these methods provides the most accurate and reliable estimate?
