Debt Offering’s Impact on The Comic Book Publication Group (CBPG)’s Cost of Capital
WACC stands for Weighted Average Cost of Capital, which is the average of the capital that, when added to the entire capital employed by the firm, gives the same amount of cost as the sum of the cost of the individual parts, or provided, in the capital. The WACC assesses the normal degree of risk associated with a company-defining initiative (Seth, 2021).
When a corporation needs money, the lowest needed rate of return, known as the capital toll, is applied (Kenton & Drury, 2020). The company’s remuneration must be more than the cost of capital used to sustain the company’s operations (Corporate Finance Institute, 2020). The WACC is calculated using a company’s capital structure, which is derived from the balance sheet, where the company’s financing sources are reported (Carlson, 2020). They are weighted to determine the overall taken a toll of capital, known as the weighted normal taken a toll of capital (WACC) (Kenton, W., & Kindness, D., 2020).
Case Study
The Comic Book Publication Group (CBPG) creates, illustrates, writes, and prints a variety of publications. It is a modest, publicly listed company. CBPG’s capital structure now consists of $12 million in bonds with a 5% yield, $5 million in preferred stock with a par value of $35 per share and an annual dividend of $1.75 per share. The book value of the company’s common stock is $6 million. The capital cost associated with common stock is 10%. The firm’s marginal tax rate is 33%.
Current Cost of Capital
The data needed to assess the current cost of capital will come from the capital structure of $12 million in bonds paying a 5% coupon; $5 million in preferred stock with a par value of $35 per share and an annual dividend of $1.75 per share. The company’s common stock has a book value of $6 million; the cost of capital is connected with the 10% common stock; and the firm’s marginal tax rate is 33% (Seth, 2021).
Total Capital and Capital Weight
To calculate CBPG’s total capital, we add the capital values of bonds, common stock, and preferred stock. The current total capital is $23 million, which has been amended to $33 million. In the current and revised tables, the capital for each component is divided by the total capital to establish the capital weight for each component in the capital structure. As predicted, the capital weights for current bonds and both stocks have decreased as a result of the additional bonds in the amended table. To ensure accuracy, the total of percentages in both tables equals 100%.
Preferred Stock Dividend Yield
The preferred stock profit abdicate must be computed by multiplying the profit rate ($1.75) by the standard esteem per share ($35.00), which equals 5.00% in both tables.
After-tax Cost of Capital
Intrigued paid on bonds may be a assessable conclusion for CBPG whereas the profit
installments are not (Chen, J., & Scott, G., 2020). To discover the after-tax fetched of obligation
capital, the bond’s intrigued cost is multiple by (1-tax rate). The after-tax fetched of capital for
existing bonds is 3.35% in both tables and the extra bonds are at 2.68% within the reexamined
table as it were. Since value capital isn’t saddled, or a 0% assess rate, the 5% cost of capital
for favored stock and 10% for common stock are not changed within the after-tax taken a toll
of capital column.
Component WACC and Total WACC
To calculate the component WACC, we multiply the weighted cost of capital (third column) by the after-tax cost of capital (fourth column) (eighth column). When the component WACCs are added together, they yield a current capital structure WACC of 5.44% and a changing capital structure WACC of 4.61%. Because the capital weights for the current bonds and both stocks decreased, their respective WACCs under the reexamined plan also decreased.
Conclusion
Looking at the bonds, we can see that the old bond’s rate has reduced from 5% to 3.35% after-tax, while the additional bond’s rate has dropped from 4% to 2.68% after-tax. This is because of the tax break on interest paid on bonds. Alternatively, common stocks began at 5% and stayed at 5%. This is an example of why obligation is less expensive than value for an open organization.
CBPG’s contribution to WACC is now 5.44%. Their adjusted WACC is 4.61%, a 15.38% reduction. This decrease is attributable to their increased usage with an additional $10 million in bond obligation, which has a lower after-tax cost of capital than any other capital structure component.
An increase in obligation will increase the D/E proportion and usage Tuovila, A., & Drury, A., 2020), and in general, obligation is less expensive than value; nevertheless, there are constraints. As a corporation gets over-leveraged, the cost of incurring further obligations rises. This is frequently why financial analysts do affectability analysis, examining several scenarios with their capital structure to establish the best combination of obligation and equity. (Kenton, W., & Kindness, D., 2020)
Based on our WACC analysis, we confirm that the CEO’s and CFO’s intuition was accurate, and the additional bonds should be released with a lower WACC of 4.61%. It is also suggested that they do an affectability analysis in order to determine their ideal capital structure and WACC.
References
Kenton, W., & Drury, A. (2020, April 23). Cost of capital definition. Retrieved December 28, 2022, from Investopedia: https://www.investopedia.com/terms/c/costofcapital.asp
Kenton, W., & Kindness, D. (2020, March 28). Sensitivity analysis. Retrieved December 28, 2022, from Investopedia: https://www.investopedia.com/terms/s/sensitivityanalysis.asp
Tuovila, A., & Drury, A. (2020, July 14). Capital structure. Retrieved December 28, 2022, from Investopedia: https://www.investopedia.com/terms/c/capitalstructure.asp
Corporate Finance Institute (2020) What is cost of capital?. Retrieved December 28, 2022, from https://corporatefinanceinstitute.com/resources/knowledge/finance/cost-of-capital/
Carlson, R. (2020, June 29). What is the weighted average cost of capital? Retrieved December 28, 2022, from https://www.thebalancesmb.com/calculate-weightedaverage-cost-of-capital-393130
Chen, J., & Scott, G. (2020, March 9). Debt financing. Retrieved December 28, 2022, from Investopedia: https://www.investopedia.com/terms/d/debtfinancing.asp
Note:
This article is written based on University of The People Financial Management (BUS 5111) written assignment by Fristy Tania in November 2022
