Question

For questions 14 and 15.

Donegal, Inc., has decided to use EVA to evaluate its performance.

Last year, Donegal had after-tax operating income of $900,000. Three sources of financing were used by the company: $2 million of mortgage bonds paying 9 percent interest, $3 million of unsecured bonds paying 11 percent interest, and $10 million in common stock, which was considered to be relatively more risky than other stocks, and had a risk premium of 8 percent. Donegal, Inc., pays a marginal tax rate of 40 percent.

14. Calculate the weighted average cost of capital for Donegal, Inc. (round to nearest 3 decimal

points).

2,000,000

.13 x .09 (1 - .04)

= .0072

3,000,000

.20 x .11 (1 - .04)

= .0132

10,000,000

.67 x .14

= .0938

why 10M need multiply 0.14

Answer 1

The given question relates to Weighted Average Cost of Calculation

WACC = (Debt/(Debt+Equity))*Rate of Interest*(1-Tax Rate) + (Equity/(Debt+Equity))*Cost of Equity(Ke)

$2 Million in Mortgage Bonds	=(2/15)*9%*(1-0.40)	=0.13*9%*(1-0.40)	0.0070	0.70%
$3 Million in Unsecured Bonds	=(3/15)*11%*(1-0.40)	=0.20*11%*(1-0.40)	0.0132	1.32%
$10 Million in Common Stock	=(10/15)*Ke	=0.67*0.14	0.0938	9.38%
Total	0.1140	11.40%

For Ke Calculation

=Rf + Beta (Rm - Rf)

OR

=Rf + Beta*Risk Premium

Data is missing in this question, as Beta should be given in question

Assuming Rf be 9% (Mortagage Bonds rate)

Beta is missing in question, assuming 0.625

Ke = 9% + 0.625*8%

14.00%