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Unit 7 Writing Assignment

The document discusses a company raising $10 million through a bond issue to add to its current capital structure valued at $23 million with a weighted average cost of capital of 7%. Issuing the new bonds would decrease the weighted average cost of capital to 6%. Based on the analysis, the author recommends the company proceed with the bond issuance as their weighted average cost of capital would remain low enough to overcome project hurdle rates.

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Rachell Ann Uson
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36 views4 pages

Unit 7 Writing Assignment

The document discusses a company raising $10 million through a bond issue to add to its current capital structure valued at $23 million with a weighted average cost of capital of 7%. Issuing the new bonds would decrease the weighted average cost of capital to 6%. Based on the analysis, the author recommends the company proceed with the bond issuance as their weighted average cost of capital would remain low enough to overcome project hurdle rates.

Uploaded by

Rachell Ann Uson
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Unit 7 Writing Assignment

University of the People

BUS 5111 – Financial Management

Instructor: Dr. John Parker

March 17, 2020


The company would like to raise $10 million by way of a bond issue. The current capital
structure consists of an existing bond, premium equity and common stock. The current capital
structure is valued at $23 million, with a weighted average cost of capital is 7%. The additional
bond offering will add $10 million to their capital stack with a weighted average cost of capital
of 6%. It should be noted that the taxes paid on the pond coupons or deductible which creates
a cash savings for the company on their taxes; on the other hand, dividends are premium equity
and common stock are not tax advantaged (Averkamp, n.d.)

Their weighted cost of the current bond issue was calculated by subtracting 33% tax rate
from the 5% coupon rate which equates to 3.35% capital cost for the bonds. The cost of
premium equity is 1% which I calculated using the component cost of preferred stock, which
calculated by dividing the $1.75 dividends by $35 per value. The common stock was calculated
using the cost of equity debt + premium model (i.e. adding the 10% common stock cost to the
4% bond rate. The market value of each Capital is divided into the total market value to get
their weighted average factor and each of those factors are multiplied by their respective
capital costs (Hargrave, 2021). Adding their weighted cost of capital together creates in
weighted average cost of capital of 7%.

This process was repeated for the additional bond offering, also using the after-tax cost
of debt, showed a cost of capital of 2.68%, a weighted average factor of 30% and a weighted
cost of capital of 1%. The new weighted average cost of capital is 6%.

Current Capital Structure:

Proposed Capital Structure:


Based on the information provided I recommend the company proceed with the $10
million bond issuance; I believe they have the resources to manage and honor their debt and
equity obligations. Overall, their weighted average cost of capital is low enough that they
should be able to overcome any project hurtle rates.
References:

Averkamp, H. (n.d.) What is the tax advantage when bonds are issued instead of stock?
https://www.accountingcoach.com/blog/tax-advantage-of-bonds-debt

Hargrave, M. (2021) Weighted Average Cost of Capital (WACC).


https://www.investopedia.com/terms/w/wacc.asp

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