University Finance Report: Cost of Capital Analysis for Bad Boys Inc

This report provides an analysis of the cost of capital for Bad Boys Inc. It evaluates the company's weighted average cost of capital (WACC) under varying capital structures, considering the use of debt, preferred stock, and common equity. The report details the steps involved in calculating the cost of debt, cost of preferred stock, and cost of common equity, along with the impact of these costs on the overall WACC. The analysis includes scenarios where the capital structure changes, demonstrating how the WACC fluctuates based on the proportion of different funding sources. The conclusion highlights that the cost of capital is a crucial metric for investment decisions and is influenced by the company's capital structure. The report provides a clear understanding of how changes in the proportions of debt, equity, and preferred stock affect the company's financial performance and overall cost of capital.

Running head: COST OF CAPITAL
COST OF CAPITAL
Name of the Student
Name of the University
Author Note

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COST OF CAPITAL
Executive Summary
The purpose of this project is to evaluate the cost of capital for Bad Boys Inc in varying capital
structure conditions, cost of capital is a strategic tool for making investment decisions. The cost
of capital is a combined return that equity shareholders and stakeholders require for investing the
funds.

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COST OF CAPITAL
Table of Contents
Introduction......................................................................................................................................3
Discussion........................................................................................................................................3
Conclusion.......................................................................................................................................6
References and Bibliography:..........................................................................................................7

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COST OF CAPITAL
Introduction
The report aims at evaluating the cost of capital of Bad Boys Inc under the varying
capital structure. The company is considering to raise the capital by issuing common stock, new
preferred stock and by debt, so for evaluating the viability, cost of capital is computed.
Discussion
An organization finance their business either through equity, or debt or through a
combination of both in appropriate proportion (Yapa 2017). It provides for evaluating whether
the minimum return that investors desire is achieved or not and is an important tool for decision
making for investing in projects. When capital is wholly funded by equity, cost of capital will be
the cost of equity, and when entirely financed by debt, then the cost of capital will be cost of debt
(Jagannathan et al. 2017). In the given scenario, Bad Boy Inc intends to raise funds by issuing
equity, debt and preferred stock as per the given proportion, then cost of capital will be the
"weighted average cost of capital."
The company decides to raise funds in the given structure: Debt – 45%, preferred stock –
5%, Common equity – 50%, then the weighted average cost of capital is computed. Steps for
computing cost of capital is as follows (García 2017):
Step 1: Cost of debt: is calculated by taking out the coupon rate post-tax, coupon rate is – 8%,
tax is 35%, so the cost of debt after tax will be – 8%(1-.35) = 5.20%.

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COST OF CAPITAL
Step 2: Cost of Preferred Stock: is computed by dividing the dividend per share (2.5) by the
current market price of stock ($25) and presented as follows:
Step 3: Cost of Common Equity: The company wants to issue new equity. The expected
dividend company decides to pay is $1.5 per share, and the current price is $20. The company
forecasts the growth of 5% for the coming years. Hence, the cost of equity is calculated as
below:
Step 4: WACC: After calculating all the cost of sources, the values will be multiplied with the
weights. The weights are the proportion of the sources in the capital structure. The calculation is
as follows:

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COST OF CAPITAL
Bad boy Inc wants to raise capital in the following structure:
Sources of Fund:
Proportion
(a)
Debt 0.30
Preferred stock 0.05
Common Equity 0.65
In the given capital structure, the cost of capital will again comprise of the cost of debt,
equity and preferred stock. The weights (sources ratio) will b multiplied with the respective
source's cost, which is computed in the above scenario. Hence the calculation is as follows:
The WACC changes when the capital structure changes, previously it was 9.09%, and
then it rises to 10.19%.

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COST OF CAPITAL
Conclusion
However, it is concluded that this is the return that the finance provides expect for
providing the funds from company. It is seen as the percentage of sources of capital changes, the
cost of capital also changes. The cost of capital is evaluated when Bad Boys Inc changes there
capital structure by raising funds from different sources of funds and hence WACC increases
when fund from debt financing is reduced.

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COST OF CAPITAL
References and Bibliography:
Fernandez, P. (2020). The Most Common Error in Valuations using WACC. Available at SSRN.
García, F. J. P. (2017). The WACC. In Financial risk management (pp. 345-351). Palgrave
Macmillan, Cham.
Jagannathan, R., Liberti, J., Liu, B., & Meier, I. (2017). A Firm's Cost of Capital. Annual Review
of Financial Economics, 9, 259-282.
Yapa Abeywardhana, D. (2017). Capital structure theory: An overview. Accounting and finance
research, 6(1).