Question

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 2015, the firm's balance sheet appeared as follows:

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

18 percent on its common stock, the firm's bonds command a yield to maturity of 66 percent, and the firm faces a tax rate of 33 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

1616

percent, what would the firm's cost of capital be (assuming the cost of debt and tax rate do not change)?

Cash	$590,000
Accounts receivable	3,620,000
Inventories	7,900,000		Long-term debt	$10,810,000
Net property, plant, and equipment	17,684,000		Common equity	18,984,000
Total assets	$29,794,000		Total debt and equity	$29,794,000

Answer 1

Cost of debt	66.00%
Tax rate	33%
After tax cost of debt	=66% * (1-33%)
After tax cost of debt	44.22%
Based on book Values
Component	Cost	Capital	Weight	Cost * Weight
Debt	44.22%	10,810,000	36.28%	16.04%
Equity	18.00%	18,984,000	63.72%	11.47%
		29,794,000	WACC	27.51%
Component	Cost	Capital	Weight	Cost * Weight
Debt	44.22%	10,810,000	22.16%	9.80%
Equity	16.16%	37,968,000	77.84%	12.58%
		48,778,000	WACC	22.38%