Cost of Capital: Case Study Solution
•Step #1:
•Calculate the cost of capital for each component
of financing
•Cost of Equity (external)
(
)
(
)
+
= + = + =
0
e
0
D 1 g 2.00 1.07
k g 0.07 15.9%
P 24
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Case Study Solution - E-Commerce - Lecture Slides, Slides of Fundamentals of E-Commerce
Students of Communication, study E-Commerce as an auxiliary subject. these are the key points discussed in these Lecture Slides of E-Commerce : Case Study Solution, Solution, Component, Financing, Equity, Weighted Average, Capital Raised, Target Capital, Cheapest Source, Internal Equity
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2012/2013
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Cost of Capital:
Case Study Solution
•^ Step #1: •^ Calculate the cost of capital for each componentof financing •^ Cost of Equity (external)^ (^ )^
+(^ )
=^ +^ =^
+^ =
D^1 g^ 2.00 1.07^0 k g^ e^0
0.07^ 15.9%
P^24
Cost of Capital:
Case Study Solution
-^ Step #2: •^ Compute the weighted average cost of capitalfor each increment of capital raised.^ •^ The firm wants to retain its target capitalstructure^ •^ The firm should always raise its cheapest sourceof funds first.
These are: • Retained earnings (internal equity)• Preferred shares• Debt up to $5 Million
Cost of Capital:
Case Study Solution
-^ The WACC for increment #1 is:^ (^ )
(^ )^
(^ ) (^ )^
(^ ) (^ ) ^ ^ ^ ^ ^ (^ )
=^ +^
^ ^ ^
^ ^
+^ +^ +^ +^
+^ +
^ ^ ^
^ ^
^ ^
^
=^
+^
−^ +
^ ^
^ + + +^ +
^ ^
^
^ ^ +^ +^ =
f a^ e^
e^ e f f f E^ D^
P
k^ k^
k^ k E^ D^ P^ E^ D^
P^ E^ D^ P 6.25 5.00.156.
6.25^ 5.0^ 1.^
6.25^ 5.0^ 1.25 1.25.
6.25^ 5.0^ 1.2510.96%
Cost of Capital:
Case Study Solution
-^ Increment #2:
Calculate total financing thatcan be acquired using internally generatedequity (retained earnings) while retaining thetarget capital structure with 50% equity. Amount of retained earnings available X = Proportion R/E comprises of target capital str =
ucture $10 Million= $20 Million^ 0.50 The firm can raise a total of $20 Million ofnew financing before it needs to issue newcommon stock.
Cost of Capital:
Case Study Solution
-^ Increment #3:
Financing in excess of $20Million will require both high-cost debt andissuing new common stock.^ The WACC forIncrement #3 is: ( )^ (^ )
(^ ) (^ )^ (^ ) (
)^ (^
) ^ ^ ^
^ ^ =^ +^
^ ^ ^
^ ^ +^ +^ +^
+^ +^ + ^ ^ ^
^ ^ =^ +^
−^ +
f a^ e^
e^ e f^ f^
f E^ D P k^ k^
k^ k E^ D^ P^ E^
D^ P^ E^ D
P 0.50 .159^ 0.40.
1 0.40^ 0.10. 11.35%