Question

​(Weighted average cost of capital​)

Crawford Enterprises is a publicly held company located in​ Arnold, Kansas. The firm began as a small tool and die shop but grew over its​ 35-year life to become a leading supplier of metal fabrication equipment used in the farm tractor industry. At the close of​ 2019, the​ firm's balance sheet appeared as​ follows:

Cash   530,000      
Accounts receivable   4,040,000      
Inventories   7,600,000   Long-term debt   10,870,000
Net property, plant, and equipment   18,718,000   Common equity   20,018,000
Total assets   30,888,000   Total debt and equity   30,888,000

At present the​ firm's common stock is selling for a price equal to its book​ value, and the​ firm's bonds are selling at par.​ Crawford's managers estimate that the market requires a return of 19 percent on its common​ stock, the​ firm's bonds command a yield to maturity of 8 ​percent, and the firm faces a tax rate of 27 percent.

a. What is​ Crawford's weighted average cost of​ capital?

b. If​ Crawford's stock price were to rise such that it sold at 1.5 times book​ value, causing the cost of equity to fall to 17 ​percent, what would the​ firm's cost of capital be​ (assuming the cost of debt and tax rate do not​ change)?

c. Crawford is considering a new business opportunity involving the acquisition of a trucking firm. What do you think the firm should do to select an appropriate cost of capital for evaluating this​ acquisition?

a. What is​ Crawford's weighted average cost of​ capital?

Answer 1

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