MGT201 GDB 2

Fall Semester 2011

“Financial Management (MGT201)”

This is to inform that Graded Discussion Board (GDB)

has been opened according to the following schedule

Schedule:

Opening Date and Time

January 16, 2012 At 12:01 AM

Closing Date and Time

January 18, 2012 At 11:59 PM

Topic/Area for Discussion

Case:-

Assuming that ABC Firm has an optimal capital structure; comprised of debt, preferred stock and common equity. In this scenario, Firm currently has 45 percent debt, 2 percent preferred stock and 53 percent common equity in its capital structure. Firm’s before-tax cost of debt is 10 percent and corporate tax rate is 40 percent; beta for common stock is 0.85 with market return 14% and T-bills return 10%; whereas cost of preferred stock is 10.3 percent.

Required:

1. Keeping in view the above mentioned information what would be the values of the firm’s:
§ After tax cost of debt ‘Kd(1 - T)’
§ Weighted average cost of capital ‘WACC’
Note: Detailed working is not required.

2. You need to stimulate your thought and discuss the impact (increase/ decrease) on firm’s cost of equity ‘Ks’ and weighted average cost of capital ‘WACC’ if volatility of ABC Firm’s stock is increased up to 1.8. Give logical justification of your answer.
Note: Your discussion should not exceed 50 words.
Guidelines for Preparation:

For acquiring the relevant knowledge, do not rely only on handouts but watch the course video lectures, which can be downloaded for free from [You must be registered and logged in to see this link.] and also use other reference books.

Important Instructions:

1. The GDB will remain open for 72 hours
2. The GDB will open and close at above specified date and time. Please note that no grace day and extra time will be given for posting comments on GDB.
3. Use the font style “Times New Roman” and font size “12”.
4. Your answer should be relevant to the topic i.e. clear and concise.
5. Do not copy or exchange your answer with other students. Two identical/ copied comments will be marked Zero (0) and may damage your grade in the course.
6. Books, websites and other reading material may be consulted before posting your comments but copying or reproducing the text from books, websites and other reading materials is strictly prohibited. Such comments will be marked as Zero (0).
7. You should post your answer on the Graded Discussion Board (GDB), not on the Moderated Discussion Board (MDB). Both will run parallel to each other during the time specified above. Therefore, due care will be needed.
8. Obnoxious or ignoble answer should be strictly avoided.
9. You cannot participate in the discussion after the due date.
10. Questions / queries related to the content of the GDB, which may be posted by the students on MDB or via e-mail, will not be replied till the due date of the GDB is over.
11. For planning your semester activities in an organized manner, you are advised to view schedule of upcoming Assignments, Quizzes and GDBs in the overview tab of the course website on VU-LMS.

After Tax cost of Debt = .10 (1-.40) = 6%

WACC = 0.45(0.10)(.6) + 0.02(0.103) + 0.53(0.134) = 10.008

Cost of equity and WACC both will increase because of increase in volatility of share price in market.