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Cornerstones of Cost Management 2nd Edition by Don Hansen ,Maryanne Mowen
Edition 2ISBN: 978-1111824402Cornerstones of Cost Management 2nd Edition by Don Hansen ,Maryanne Mowen
Edition 2ISBN: 978-1111824402 Exercise 33
Calculating Weighted Average Cost of Capital and Economic Value Added (EVA)
Ignacio, Inc., had after-tax operating income last year of $1,196,500. Three sources of financing were used by the company: $2 million of mortgage bonds paying 4 percent interest, $4 million of unsecured bonds paying 6 percent interest, and $9 million in common stock, which was considered to be relatively risky (with a risk premium of 8 percent). The rate on long-term treasuries is 4 percent. Ignacio, Inc., pays a marginal tax rate of 30 percent. (Round all ratios to four significant digits.)
Required:
1. Calculate the after-tax cost of each method of financing.
2. Calculate the weighted average cost of capital for Ignacio, Inc. Calculate the total dollar amount of capital employed for Ignacio, Inc.
3. Calculate economic value added (EVA) for Ignacio, Inc., for last year. Is the company creating or destroying wealth?
4. What if Ignacio, Inc., had common stock which was less risky than other stocks and commanded a risk premium of 5 percent? How would that affect the weighted average cost of capital? How would it affect EVA?
Ignacio, Inc., had after-tax operating income last year of $1,196,500. Three sources of financing were used by the company: $2 million of mortgage bonds paying 4 percent interest, $4 million of unsecured bonds paying 6 percent interest, and $9 million in common stock, which was considered to be relatively risky (with a risk premium of 8 percent). The rate on long-term treasuries is 4 percent. Ignacio, Inc., pays a marginal tax rate of 30 percent. (Round all ratios to four significant digits.)
Required:
1. Calculate the after-tax cost of each method of financing.
2. Calculate the weighted average cost of capital for Ignacio, Inc. Calculate the total dollar amount of capital employed for Ignacio, Inc.
3. Calculate economic value added (EVA) for Ignacio, Inc., for last year. Is the company creating or destroying wealth?
4. What if Ignacio, Inc., had common stock which was less risky than other stocks and commanded a risk premium of 5 percent? How would that affect the weighted average cost of capital? How would it affect EVA?
Explanation
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Cornerstones of Cost Management 2nd Edition by Don Hansen ,Maryanne Mowen
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