Problem
The Comic Book Publication Group (CBPG) specializes in creating, illustrating, writing, and printing various publications. It is a small but publicly traded corporation. CBPG currently has a capital structure of $12 million in bonds that pay 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 has common stock with a book value of $6 million. The cost of capital associated with the common stock is 10%. The marginal tax rate for the firm is 33%.
The management of the company wishes to acquire additional capital for operations purposes. The chief executive officer (CEO) and chief financial officer (CFO) agree that another public debt offering (corporate bonds) in the amount of $10 million would suffice. They believe that due to favorable interest rates, the company could issue the bonds at par with a 4% coupon.
Before the Board of Directors convenes to discuss the debt Initial Public Offering (IPO), the CFO wants to provide some data for the board of directors' meeting notebooks. One point of the analysis is to evaluate the debt offering's impact on the company's cost of capital.
I. Solve for the current cost of capital of CBPG on a weighted average basis
II. Solve for the new cost of capital, assuming the $10 million bond issued at par with a 4% coupon.
III. Describe how you approached these calculations. Also discuss the tax shield advantage that debt capital provides, and briefly explain the cost of capital and WACC
IV. Provide a Table(s) to present answers (Students can transfer their EXCEL Table if utilized)
Summarize findings
Superior papers will explain the following elements when responding to the assignment questions:
I. Provide narrative and solve for the current cost of capital of CBPG on a weighted average basis (WACC).
II. Provide narrative and solve for the new cost of capital (WACC).
III. Provide accurate WACC calculations for both scenarios.
IV. Provide a Table(s) to present answers (there is a difference between performing calculations and presenting the supporting data and solved answers).
V. Provide narrative on tax shield implications for both scenarios.
VI. Provide narrative briefly explaining the cost of capital and WACC.
VII. Provide a clear, logical conclusion.