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    Ch09 P18 Build A Model

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    sadoleh
    This document provides inputs and calculations to build a capital budgeting model for a company called Gao. It includes: 1) Calculating the costs of debt, preferred stock, and equity using the DCF and CAPM methods. 2) Calculating the cost of new common stock issued using the DCF method and CAPM. 3) Calculating the company's weighted average cost of capital (WACC) assuming the current capital structure. 4) Analyzing 3 potential projects with different betas and expected returns, and explaining whether each should be accepted based on comparing their returns to the WACC.

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    Ch09 P18 Build A Model

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    sadoleh
    396 views2 pages
    This document provides inputs and calculations to build a capital budgeting model for a company called Gao. It includes: 1) Calculating the costs of debt, preferred stock, and equity using the DCF and CAPM methods. 2) Calculating the cost of new common stock issued using the DCF method and CAPM. 3) Calculating the company's weighted average cost of capital (WACC) assuming the current capital structure. 4) Analyzing 3 potential projects with different betas and expected returns, and explaining whether each should be accepted based on comparing their returns to the WACC.

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    Ch09 P18 Build a Model

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    This document provides inputs and calculations to build a capital budgeting model for a company called Gao. It includes: 1) Calculating the costs of debt, preferred stock, and equity using the DCF and CAPM methods. 2) Calculating the cost of new common stock issued using the DCF method and CAPM. 3) Calculating the company's weighted average cost of capital (WACC) assuming the current capital structure. 4) Analyzing 3 potential projects with different betas and expected returns, and explaining whether each should be accepted based on comparing their returns to the WACC.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    396 views2 pages

    Ch09 P18 Build A Model

    Uploaded by

    sadoleh
    This document provides inputs and calculations to build a capital budgeting model for a company called Gao. It includes: 1) Calculating the costs of debt, preferred stock, and equity using the DCF and CAPM methods. 2) Calculating the cost of new common stock issued using the DCF method and CAPM. 3) Calculating the company's weighted average cost of capital (WACC) assuming the current capital structure. 4) Analyzing 3 potential projects with different betas and expected returns, and explaining whether each should be accepted based on comparing their returns to the WACC.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    of 2

    Doleh, Sufian

    FIN 501

    7/14/2013 0:00

    4/16/2010

    Chapter 09. Ch09 P18 Build a Model


    INPUTS USED IN THE MODEL P0 Net Ppf Dpf D0 g B-T rd Skye's beta Market risk premium, RPM Risk free rate, rRF Target capital structure from debt Target capital structure from preferred stock Target capital structure from common stock Tax rate Flotation cost for common $50.00 $30.00 $3.30 $2.10 7% 10% 0.83 6.0% 6.5% 45% 5% 50% 35% 10%

    a. Calculate the cost of each capital component, that is, the after-tax cost of debt, the cost of preferred stock (including flotation costs), and the cost of equity (ignoring flotation costs). Use both the DCF method and the CAPM method to find Cost of debt: B-T rd (1 T) = A-T rd

    Cost of preferred stock (including flotation costs): Dpf / Net Ppf = rpf

    Cost of common equity, DCF (ignoring flotation costs): D1 / P0 + g = rs

    Cost of common equity, CAPM: rRF


    +

    b RPM

    = =

    rs

    IMPORTANT NOTE: HERE THE CAPM AND THE DCF METHODS PRODUCE APPROXIMATELY THE SAME COST OF EQUITY. THAT OCCURRED BECAUSE WE USED A BETA IN THE PROBLEM THAT FORCED THE SAME RESULT. ORDINARILY, THE TWO METHODS WILL PRODUCE SOMEWHAT DIFFERENT RESULTS.

    b. Calculate the cost of new stock using the DCF model. D0 (1 + g) / P0 (1 F) + g = re

    c. What is the cost of new common stock based on the CAPM? (Hint: Find the difference between r e and rs as determined by the DCF method and add that differential to the CAPM value for r s.) rs + + Differential = = re

    Again, we would not normally find that the CAPM and DCF methods yield identical results. d. Assuming that Gao will not issue new equity and will continue to use the same capital structure, what is the company's WACC? wd wpf ws 45.0% 5.0% 50.0% 100.0% wd A-T rd + wpf rpf + ws rs = = WACC

    e. Suppose Gao is evaluating three projects with the following characteristics: (1) Each project has a cost of $1 million. They will all be financed using the target mix of long-term debt, preferred stock, and common equity. The cost of the common equity for each project should be based on the beta estimated for the project. All equity will come from reinvested earnings. (2) Equity invested in Project A would have a beta of 0.5 and an expected return of 9.0%. (3) Equity invested in Project B would have a beta of 1.0 and an expected return of 10.0%. (4) Equity invested in Project C would have a beta of 2.0 and an expected return of 11.0%. Analyze the companys situation and explain why each project should be accepted or rejected. Expected return on project

    Project A Project B Project C

    Beta 0.5 1.0 2.0

    rs

    rps

    rd(1 T)

    WACC

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