Estimate the firms after-tax cost for long debt

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Reference no: EM131715648

Case Study - Sugar Cane Refining And Processing Company: A Comprehensive Case In Measuring A Firm's Cost Of Capital

INTRODUCTION

What is a firm's cost of capital? A firm's cost of capital is precisely as its name implies. When a firm raises capital from its lenders and owners, both investors require a return on their investment. Debt investors (lenders) expect to be paid interest on their loans and equity investors require dividends or capital appreciation as their return.

QUESTIONS

1. SCRPC uses notes to finance its working capital and its seasonal needs. Should the firm use its cost of notes in the measure of the cost of capital?

2. Estimate the firm's after-tax cost for long debt. Why do analysts use the after-tax measure in the calculation of a firm's cost of capital?

3. Calculate SCRPC's cost for preferred stock. Why is there not a tax adjustment?

4. Calculate the cost for the current common stock investors.

(a) Estimate the cost for common stock using the Gordon Model (dividend valuation model).

(b) Calculate the cost of common stock using the Capital Asset Pricing Model.

5. Calculate SCRPC's cost of capital when retained earnings is the source of common stock financing and the Gordon Model estimate is used. Use current market values of the financial instruments to determine the components weights (see Exhibit VI).

6. What is SCRPC's cost of capital when the firm has to issue new common stock and the Gordon Model estimate is used? (See Exhibit VII).

7. Calculate the "Break Point" that is when the firm while maintaining its exact optimal structure would have to start issuing new common stock for additional capital. The equation to find the Break Point is: Break Point = Retained Earnings for the Period / Weight of Common Stock

8. Draw a graph representing the firms' Marginal Cost of Capital. Label the vertical line dollars and name the horizontal line as interest rate. The graph should illustrate SCRPC's cost of capital.

9. Should market values or book values be used in the estimation of a firm's cost of capital. Defend your recommendation.

10. Preferred stock is more risky than long-term debt yet in many instances the yield to the bond holder is higher than to the preferred stockholder. Explain this paradigm.

Attachment:- Assignment File.rar

Reference no: EM131715648

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len1715648

11/10/2017 3:32:26 AM

Detailed Question: Must complete questions 1-6 and 9 on page 5-6 of attachment. Short answer with calculations. No essay needed. To determine the cost of capital, first identify each component that makes up the firm’s long-term financing mixture. Determine each individual component’s before tax and after tax cost. Determine the weights or contribution of each component to the firm’s capital structure and prepare a Cost of Capital Matrix. Find the Break Point for Retained Earnings.

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