Key Assignment
Your next assignment as a financial management intern is to apply the knowledge that you acquired while engaging in the cost of capital discussion that you had with your colleagues. In this task, you will be calculating the weighted cost of capital for a firm using the book value of the components and the concepts presented in this phase.
Using the most current annual financial statements from the company you analyzed in Phase 1, determine the percentage of the firm’s assets that are currently be financed with debt (total liabilities), preferred stock, and common stock (common equity). It is very possible that your firm will have very little or no preferred stock, so in this class, the percent would be “zero.” Your ratios should add up to 100%. You will also need to calculate the firm’s average tax rate using the income tax expense divided by the firm’s income before taxes. Use the following tables:
Company 
Total Assets 
Total Liabilities 
Total Preferred Stock 
Total Common Equity 
Dollar Value 

% of Assets 
Company 
Income before Tax 
Income Tax Expense 
Average Tax Rate (%) 
The first component to determine is the cost of debt. You mentor suggests using the Web site that you used in the previous Phase to find the pretax yieldtomaturity of a bond with at least 5 years left before maturity. Using the following table, calculate the firm’s aftertax cost of debt:
Yield to Maturity 
1 – Average Tax Rate 
Aftertax Cost of Debt 
Now you will need to calculate the cost of preferred stock. You can use the following table:
Annual Dividend 
Current Value of Preferred Stock 
Cost of Preferred Stock (%) 
To calculate the cost of common equity, you can use the CAPM model. Using current stock data, the yield on the 5year treasury bond, and the return on the market calculated in Phase 2, you can calculate the cost of common equity using the following table:
5year Treasury Bond Yield 
Stock’s Beta 
Return on the Top 500 Stocks (market return) 
Cost of Common Equity 
Now, you can use the cost and ratios from above to calculate the firm’s weighted average cost of capital (WACC) using the following table:
AfterTax Cost of Debt 
Cost of Preferred Stock 
Cost of Common Equity 
WACC 

Unweighted Cost 

Weight of Component 

Weighted Cost of Component 

After completing the required calculations, explain your results in a Word document, and attach the spreadsheet showing your work. Be sure to explain the following:

How would you expect the weighted average cost of capital (WACC) to differ if you had used market values of equity rather than the book value of equity, and why?

What would you expect would happen to the cost of equity if you had to raise it by selling new equity, and why?

If the aftertax cost of debt is always less expensive than equity, why don’t firms use more debt and less equity?

What are some of the advantages and disadvantages of raising capital by using debt?

How would “floatation costs” impacted the WACC, and how could they have been incorporated in the formula?
Note: You can find information about the top 500 stocks at this Web site. http://finance.yahoo.com/echarts?s=%5egspc+interactive#{}
Reference
S&P 500 index chart. (2014). Retrieved from the Yahoo! Finance Web site: http://finance.yahoo.com/echarts?s=%5egspc+interactive#symbol=^gspc;range=1y;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=;
Be sure to document your paper with intext citations, credible sources, and list of references used in proper APA format. Word document of 700–1,000 words with attached Excel Spreadsheet showing calculations
· Determine the relationship between risk and return by calculating stock and portfolio variance.
· Determine the firm’s cost of capital.
· Use effective communication, team and problemsolving skills to collaborate on a project.
Using the most current annual financial statements from the company you analyzed in Phase 1, determine the percentage of the firm’s assets that are currently be financed with debt (total liabilities), preferred stock, and common stock (common equity). It is very possible that your firm will have very little or no preferred stock, so in this class, the percent would be “zero.” Your ratios should add up to 100%. You will also need to calculate the firm’s average tax rate using the income tax expense divided by the firm’s income before taxes.


The first component to determine is the cost of debt. You mentor suggests using the Web site that you used in the previous Phase to find the pretax yieldtomaturity of a bond with at least 5 years left before maturity. Using the following table, calculate the firm’s aftertax cost of debt:

2. Now you will need to calculate the cost of preferred stock. You can use the following table:

3. To calculate the cost of common equity, you can use the CAPM model. Using current stock data, the yield on the 5year treasury bond, and the return on the market calculated in Phase 2, you can calculate the cost of common equity using the following table:

4. Now, you can use the cost and ratios from above to calculate the firm’s weighted average cost of capital (WACC) using the a table

After completing the required calculations, explain your results in a Word document, and attach the spreadsheet showing your work. Be sure to explain the following:

1. How would you expect the weighted average cost of capital (WACC) to differ if you had used market values of equity rather than the book value of equity, and why?

2. What would you expect would happen to the cost of equity if you had to raise it by selling new equity, and why?

3. If the aftertax cost of debt is always less expensive than equity, why don’t firms use more debt and less equity?

4. What are some of the advantages and disadvantages of raising capital by using debt?


How would “floatation costs” impacted the WACC, and how could they have been incorporated in the formula?
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