http://www.maniacsolutions.com/marketing-value-proposition/
capital cost of problem?
Poulsbo manufacturing inc is currently an all equity firm that pays no taxes. The market value of equity the company is 3 million euros. The cost of this unlevered equity is 15% per annum. 600,000.00 Poulsbo plans to issue debt and use the proceeds to buy back the cost debt is 4% semi-annually. After a repurchase Poulsbo) population, which goes to companies weighted average cost of capital? b) After the repurchase, What is the cost of equity be? Explain c) Using MM-Proposition 2 which is the weighted average cost of capital after the repurchase?
a.) Currently the company is weighted at 100% common stock. If you use $ 600,000 in debt from buying back $ 3 billion in common stock investors still will have $ 3.0 M in debt and common stock combined. This is because they did not buy real assets (as the accounting equation A = P + E is true). Now only has $ 2.4M in equity and $ 600,000 in debt. To find our new pesos, using the formula: Wd = Total Debt / (Total Debt + Total equity common) Wd = 600000/3000000 Wd = 20% L + E is the debt we = Total Common Equity / (Total Debt + Equity Total Common) We = 2,400,000 / Nos 3 million = 80% L + E is common equity Now we have the equation for the WACC, which looks like this: WACC = (WD) (1-T) (RD) + (We) (Re) + (Wp) (Rp ) Where: WACC = weighted average cost of capital Wd = Weight of debt (%) = Weight We common shares (%) Wp = Weight of the preference shares (%) = Rd Cost of debt (%) Re = Cost of capital (%) Rp = Cost of preferred stock (%) T = Tax rate (%) As in this example there are no taxes or preferred stock, the problem is greatly simplified. WACC = (20% * 4%) + (80% * 15%) 12.8% WACC = b.) If you do not use the MM2 model, we find that the cost of capital remains the same regardless of the capital structure of the company. However, we can use the model of Modigliani-Miller Proposition II to meet the cost of capital, if desired. R = Ro + (B / S) * (Ro-Rb) R is the cost of capital Ro is the cost of capital for an all equity firm Rb is the cost of the debt of B / S is the debt- capital ratio (total debt over total equity) R = 15% + (0.25) * (15% -4%) R = 17.75% Why? Wikipedia says: "A greater proportion of debt to equity leads to a higher required return on capital, due to the higher risk involved for the holders of shares in a company with debt. "http://en.wikipedia.org/wiki/Modigliani-Miller_theorem c.) If re-calculate the WACC using the MM2 model, we find: WACC = (WD) (1-T) (RD) + (We) (Re) + (Wp) (Rp) WACC = (20 % * 4%) + (80% * 17.75%) WACC = 15%
Value Proposition : Neil Rackham on the importance to sales