Mgt201 Assignment No. 2 Solution
Tuesday, January 11, 2011 Posted In MGT Edit ThisAssignment # 02 Marks: 20
“Weighted Average Cost of Capital and Leverage”
Debentures: Firm’s Debentures can be sold at an interest rate of 13%.
Preferred stock: Firm can sell 9% preferred stock at its par value of Rs.100 pershare.
The cost of issuing and selling the preferred stock is expected to be Rs.10 per share.
Common stock: The firm’s common stock is currently selling for Rs.80 per share. The firm expects to pay cash dividends of Rs.9 per share next year. The firm’s dividends have been growing at annual rate of 5% and this is expected to continue in future. Floatation costs are expected to amount Rs.5 per share.
Sources of capital Weights
Long‐term debt 30%
Preferred stock 30
Common stock equity 40
The firm is in 35% tax bracket.
i. Calculate the specific cost of each source of financing
ii. Calculate the weighted average cost of capital?
Question # 02
Given the price and cost data shown in the following table of each of the two
firms A and B, answer the following questions.
Sales price per unit Rs.16.00 Rs.20.00
Variable operating cost per unit 6.75 9.75
Fixed operating cost 24,600 30,600
What is the operating breakeven point in units for each firm?
(Show complete calculations and provide all formulas as they carry marks)
Schedule
Opening Date and Time January 10, 2011 At 12:01 A.M. (Mid-Night)
Closing Date and Time January 13, 2011 At 11:59 P.M. (Mid-Night)
.................
Solution:
Question No. 1
Cost of equity = [9 / (80-5)] + .05 = 0.17
Cost of preferred stock = 9/90 = .10
WACC = rD XD. (1-Tax) + rP XP + rE XE .
WACC = .30 x .13 (1-.35) + .30 x .10 + .40 x 0.17
WACC = 0.02535 + .03 + 0.068
WACC = 0.12335
WACC = 12.335
Question No. 2
Break even point in units = Fixed expenses / Unit contribution margin
Break even point in units Firm A = 24600 / (16-6.75) = 2660
Break even point in units Firm B =30600 / (20-9.75) = 298
Cost of equity = [9 / (80-5)] + .05 = 0.17
Cost of preferred stock = 9/90 = .10
WACC = rD XD. (1-Tax) + rP XP + rE XE .
WACC = .30 x .13 (1-.35) + .30 x .10 + .40 x 0.17
WACC = 0.02535 + .03 + 0.068
WACC = 0.12335
WACC = 12.335
Question No. 2
Break even point in units = Fixed expenses / Unit contribution margin
Break even point in units Firm A = 24600 / (16-6.75) = 2660
Break even point in units Firm B =30600 / (20-9.75) = 298
