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SEMESTER “FALL 2010”
Financial Management (MGT201)
Assignment # 02 Marks: 20
“Weighted Average Cost of Capital and Leverage”
Question # 01
XYZ Enterprises is interested in measuring its overall cost of capital. Current
investigation has collected the following data.
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.
Firm A B
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)
Important Tips
This Assignment can be best attempted from the knowledge acquired after
watching video lecture# 1 to lecture # 31 and reading handouts as well as
recommended text book.
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)
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### Replies to This Discussion

This is an Idea solution by Asad Munir pls do not copy paste as it is.
Intellectual and positive comments will be appreciated

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) = 2985
this sol is correct my q1 answer is 13.335...also refer handouts page number 125-126
Thanks
See the attached file for another idea solution
Attachments:
Please tell which solution is correct?

another idea solution attached file please see the attached file

Attachments:
I think this solution is accurate  as compare to others according to ma knowledge and I also can explain this in detail..........
1. About which solution u r talking ??? Dua??
Attachments:

Question 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) = 2985

Question # 02
Given the price and cost data shown in the following table of each of the two

Firms A.
Firm A B
Sales price per unit Rs. = 16.00
Variable operating cost per unit = 6.75
Fixed operating cost = 24,600

Q = F / (P - V)

Q= Quantity or Number (Break Even Point)
F= Fixed Cost
P= Product Price
V= Variable Cost of product per unit (Rs.),

Break-Even Point Q = Fixed Cost / (Unit Price - Variable Unit Cost)
= 24600 / (16.00-6.75)
=24600/9.26
=2656 Units

Firms B-
Sales price per unit Rs. = 20.00
Variable operating cost per unit = 9.75
Fixed operating cost = 30,600

Q = F / (P - V)

Q= Quantity or Number (Break Even Point)
F= Fixed Cost
P= Product Price
V= Variable Cost of product per unit (Rs.),

Break-Even Point Q = Fixed Cost / (Unit Price - Variable Unit Cost)
= 30600 / (20.00-9.75)
=30600/10.25
=2985 Units

Q -1

1- Cost of Debentures: 13%
2- Cost of Preferred Stock:-

Sell Preferred Stock = 9%
Value of Sell Preferred Stock = Rs 100 / Share = PV (Po)
Cost of issuing and selling expected = Rs 10 / share = DIVI
Required Return (Preferred Stock) = Rp ?

PV = Present Price = Po= DIV1 / r.

Po= DIV1 / r.
r = DIV1 / Po
r = 10/100 = 0.1
rp =10%

3- Cost of Common Stock:-

Sell Common Stock = 9%
Value of Sell Common Stock = Rs 80 / Share = PV (Po)
Expects to pay dividends = Rs 9 / Share = DIVI
Growth at annual Rate = 5% / Share = g
Floatation costs expected = Rs 5 / share =
Required Return (Preferred Stock) = Re ?
re = (DIV1/Po) + g
Approach I:
Retained Earnings Approach (use Market Price)
r = (DIV1/Po) + g
r = 9 / 80 + 0.05
r = 0.1125+.05
r p= 0.1625 = 16.25%
Approach II: New Stock Issuance Approach
Net Proceeds = Price - Flotation Costs = 80 - 5 = 75
r = (DIV1/NP) + g
r = 9 /75 + 0.05
r = 0.12 + 0.05
rp = 0.17 = 17%

4- Tax Bracket
Tax Bracket = 35%
Debentures = 13%
R = ?
Rd = Debenture (1- Tax)

Rd = 13% (1-tax)
Rd = 0.13 ( 1 – 0.35)
Rd (after Tax) = 0.0845= 8.45%

5- Sources of Capital
Debenture (Weight) xd = 30%
Proffered Stock (Weight) xe = 30%
Common Stock (Weight) xp = 40%

Debenture = (d) = rd = 13%
Proffered Stock (e) = re = 10%
Common Stock (p) = rp = 17%

Weighted % Cost of Debt + Weighted % Cost of Common Equity + Weighted
% Cost of Preferred Equity
WACC % = rDxD + rExE + rPxP

WACC = {(8.45%) x (30%)} + {(10%) x (30%)} + {(17%) x (40%)}
WACC = 0.02535 + 0.03 + 0.068
WACC = 0.12335
In percent = 12.335%

Second potion
(Through Approach – 1 re (Rate of return Common stock )
1- Sources of Capital
Debenture (Weight) xd = 30%
Proffered Stock (Weight) xe = 30%
Common Stock (Weight) xp = 40%

Debenture = (d) = rd = 13%
Proffered Stock (e) = re = 10%
Common Stock (p) = rp = 16.25%

Weighted % Cost of Debt + Weighted % Cost of Common Equity + Weighted
% Cost of Preferred Equity
WACC % = rDxD + rExE + rPxP

WACC = (8.45%) + (30%) + (10%) x (30%) + (16.25%) x (40%)
WACC = 0.02535 + 0.03 +0.065
WACC = 0.12035
In percent = 12.035%

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