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ABBC Inc
ABBC Inc. operates a very successful chain of yogurt and coffee shops spread across the southwestern part of the United States and needs to raise funds for its planned expansion into the Northwest. The? firm's balance sheet at the close of 2019 appeared as? follows:
Cash
$1,950,000
Accounts receivable
4,740,000
Inventories
1,520,000
Long-term debt
$8,787,000
Net property, plant, and equipment
32,416,000
Common equity
31,839,000
Total assets
$40,626,000
Total debt and equity
$40,626,000
At? present, the? firm's common stock is selling for a price equal to 3 times its book? value, and the? firm's investors require a return of 18 percent. The? firm's bonds command a yield to maturity of 9 ?percent, and the firm faces a tax rate of 28 percent. At the end of the previous? year, ABBC's bonds were trading near their par value.
a. What does? ABBC's capital structure look? like?
b. What is? ABBC's weighted average cost of? capital?
c. If? ABBC's stock price were to rise such that it sold at 3.5 times its book value and the cost of equity fell to 15 ?percent, what would the? firm's weighted average cost of capital be? (assuming the cost of debt and tax rate do not? change)?
d. ?Historically, ABBC has owned each of its yogurt shop stores. The? firm's new CFO has asked you to consider the potential effect on the? firm's cost of capital if it were to sell the stores to a real estate investor with an agreement to lease them back? (i.e., rent? them).
Expert Solution
a). Capital structure ;
Weight of debt = 8.42%
Weight of equity = 91.58%
b). Weighted average cost of capital = 17.03%
c). Weighted average cost of capital = 14.38%
d). The company would assume less debt financing than it will have a higher after tax cost or in case of higher debt financing than it will have lower after tax cost.
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