CORPORATE FINANCE Harvard Case Solution & Analysis


Question no 1:

Cost of Equity
Share Price $ 50.00
Dividend $ 2.50
Dividend Growth Rate 5%
Flotation Cost per Share $ 5.00
Percentage Floating Cost 10%
Cost of Equity (RE) 10.25%
Cost of New Common Stock 9.50%
Weighted Average Cost of Equity 9.88%

Cost of Debt
Bonds Rate 6.50%
Additional Debt Rate 8%
Average Debt Rate 7.25%
Tax Rate 34%

WACC 7.84%

Cost of Equity

Corporate Finance Case Solution

Question no 1 (b):

The capital spending project that San dusky has under consideration is the acquisition of the rival firm with the cost of $10 million. To acquire the firm, the $3 million retained earnings will be used and the remaining $3 million would be raised through the new issuance of common stock. The rest of the amount would be funded through the debt. Bonds will meet the requirement of the debt;however additional debt of $.5 million will be needed.
The weighted average cost of equity will be 7.50%, which is calculated through the average of cost of equity from the retained earnings and the new common issue as shown in the exhibit. The $3 million of retained earnings is the 50% of the equity that will be used and 50% will be the new common shares. The cost of retained earnings will be 10.25% and the cost of new common shares is 9.50% along with the weighted average cost of equity that is 7.50%.
The cost of debt for the project will be 6.50% for the 3.5 million and 8% for the $.5 million. The weighted average cost of debt will be 7.25%.
The WACC with the debt of 40% and equity of 60% is 6.64%. San dusky should go ahead as the internal rate of return is higher than the cost of capital. The higher IRR on a project than the cost of capital means higher net cash flows to the investor............

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