Written Assignment 7

Written Assignment 7
Background
The Management Team of Comic Book Publication Group (CBPG) are at a crossroads in the
growth of the company, they are considering to raise capital of 10 Million at par with coupon
rate of 4%. The company has built a brand around creative, illustration, writings and printing.
Their operation is presently a small one with a capital structure consisting $12 million in bonds
that pay a 5% coupon, $5 million in preferred stock with a par value of $35 per share and an
annual dividend of $1.75 per share. CBPG’s common stock portfolio stands at 6 Million at book
value with dividend of 10% and the marginal tax rate for the firm is 33%.
Management requires the blessing of the board of directors in order to move ahead.
Cost of Capital
The term Cost of Capital speaks to the expense incurred in order to acquire the capital needed to
run a business. These cost come in the form of debt or equity.
Solve for the current cost of capital of CBPG on a weighted average basis
According to Upwork Team (2022) WACC is a metric used to assess the different cost
associated with different financing variables. The formula for finding the weighted average cost
of capital is as follows;
WACC = {(E/V) x Re} + {(D/V) x Rd x (1 – Tc)}
Where:
E = Market Value of the company’s equity
D = Market Value of the company’s debt

V = Combined equity and debt
Re = Cost of equity
Rd = Cost of debt
Therefore WACC =
{(0.937 x .0517} + {(0.062 x 0.05)} x (1 - .33)}
= (0.048 + 0.0031) x (.67)
= 5.01. This means for every dollar earned Comic Book Publication Group (CBPG) will spend
$5.01.
Solve for the new cost of capital, assuming the $10 million bond issued at par with a 4%
coupon.
Where:
Re = Cost of equity
Rd = Cost of debt Upwork Team (2022)
Therefore;
{(0.937 x .0517} + {(0.003 x 0.05)} + {(0.002 x .04)} (1 – .33)}
= (0.048 + (0.00015 + 0.00008 x.67)
= 0.048 + (.00023 x .67)
=.0481541 or 4.82%
For every dollar earned Comic Book Publication Group (CBPG) will spend $4.82
Describe how you approached these calculations. Also discuss the tax shield advantage that
debt capital provides, and briefly explain the cost of capital and WACC
The acronym WACC stands for Weighted Average Cost of Capital. The name suggests that by
averaging the elements involved in the capital financing expense the Management can identify
how much each capital contribution cost (equity or debt).
The process of arriving at the WACC involves execution of the formula which is presented
below.
Where:
Re = Cost of equity
Rd = Cost of debt
The process involves applying the BOMDAS principle, which stipulates Brackets, then order or
'of' in some curricula, then multiplication and division, then addition and subtraction. First find
the ratio of total equity versus the total capital structure and multiply this figure by the cost of
equity. Secondly, repeat this step to arrive at the ratio of debt to total equity and once again
multiply it by the percentage cost of debt. Calculate the tax rate in the last bracket and multiply it
against the debt ratio to acquiring the discount effect of the tax shield. Efinancial Models (2022)
Finally add all the different variables together, thereby arriving at the figure which indicates how
much each dollar of revenue cost the company.
Analysis and Recommendations
The capital structure of a company is composed of equity and or debt financing, or in other word
shares in the entity which possess value allowing for them to be traded or sold. Stocks also pay
dividends and allow for voting rights in the case of the common stock. Conversely, debt
financing takes the form of loans, a corporate bond is an example of debt financing which allows
the company to access loans from multiples investors at once.
The cost of capital in this scenario is the coupon rate of return which must be paid as dictated in
the prospectus. The initial cost of capital result was $5.01 for every dollar of revenue and when
the Corporate Bond was added this figure changed to $4.82. This translates into a .19 cents
saving on the cost the finance the company’s capital. Counting Up (2022)
Impact of the Tax Shield
The portion of the formula which states (1 – Tc)} is used to calculate the discounting effect of
the tax shield. Tax deductible is a beneficial feature of debt financing as these figures can be
reclaimed by the company hence reducing the cost to the company.
WACC Scenario 1 WACC Scenario 2

{(E/V) x Re} {(0.937 x .0517} {(E/V) x Re} {(0.937 x .0517}
{(D/V) x Rd {(0.062 x 0.05)} {(D/V) x Rd 0.00015 + 0.00008
(1 – Tc)} (1 - .33)} (1 – Tc)} (1 – .33)}
Results of Scenario 1 $5.01. Results of Scenario 2 $4.82.
Recommendations
Board should approve the issuing of the Corporate Bond valuing 10 million at 4% because it
appears to reduce cost of financing additionally debt financing is relatively safe and reliable. It
mitigates against the risk of losing the control of the company of diluting the stock value, while
allowing the company to achieve its goals.
References
Counting Up (2022) Using WACC Formula to Calculate the Cost of Capital, Accessed By;
https://countingup.com/resources/using-the-wacc-formula-to-calculate-cost-of-capital/
Efinancial Models (2022) How To Calculate The Weighted Average Cost of Capital, Accessed
by, https://www.efinancialmodels.com/knowledge-base/valuation/discount-rate/how-to-
calculate-the-weighted-average-cost-of-capital-wacc/
Upwork Team (2022) How to calculate Weighted Average Cost Of Capital, Accessed by;
https://www.upwork.com/resources/how-to-calculate-wacc

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Written Assignment 7

WACC = {(E/V) x Re} + {(D/V) x Rd x (1 – Tc)}

E = Market Value of the company’s equity

D = Market Value of the company’s debt

WACC = {(E/V) x Re} + {(D/V) x Rd x (1 – Tc)}

{(0.937 x .0517} + {(0.062 x 0.05)} x (1 - .33)}

= (0.048 + 0.0031) x (.67)

WACC = {(E/V) x Re} + {(D/V) x Rd x (1 – Tc)}

E = Market Value of the company’s equity

D = Market Value of the company’s debt

V = Combined equity and debt

Rd = Cost of debt Upwork Team (2022)

= (0.048 + (0.00015 + 0.00008 x.67)

= 0.048 + (.00023 x .67)

WACC = {(E/V) x Re} + {(D/V) x Rd x (1 – Tc)}

E = Market Value of the company’s equity

D = Market Value of the company’s debt

V = Combined equity and debt

Analysis and Recommendations

Impact of the Tax Shield

WACC Scenario 1 WACC Scenario 2

Results of Scenario 1 $5.01. Results of Scenario 2 $4.82.

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