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Cost of Capital Assessment

By:   •  March 18, 2019  •  Essay  •  1,216 Words (5 Pages)  •  46 Views

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Cost of Capital (Part 1 of 2)

Situation: Bad Boys, Inc. is evaluating its cost of capital. Under consultation, Bad Boys, Inc. expects to issue new debt at par with a coupon rate of 6% (PRE-TAX RATE) and to issue new preferred stock with a $3.00 (DIVIDEND) per share at $25 (PRICE) a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 (P0) a share. Bad Boys, Inc. expects to pay a dividend of $1.75 (D1) per share next year. An equity analyst foresees a growth in dividends at a rate of 5% (G) per year. Bad Boys, Inc. marginal tax rate is 40% (MARGINAL TAX RATE). Known Information: Cost of Capital = TBD

Cost of Capital (WACC) using these numbers is determined by multiplying the percentage weight of the capital used by Bad Boys, related to their debt, preferred stock and equity, by the percentage cost of the items as calculated from the cost table A.

# A

COST OF EQUITY = (D1/P0) + G = (1.75/20)+.05 = 0.05

4.50

COST OF PREFERRED STOCKS = DIVIDEND/PRICE = (3/25) = 0.12

12.00

COST OF DEBT after TAXES = PRE-TAX COST * (1-TAX RATE) = .06*(1+.40) = 0.08

8.40

Scenario #1: If Bad Boys raise Capital as follows: 35% debt, 10% preferred stock and 55% common stock then the Cost of Capital is 6.62%

Scenario #2: If Bad Boys capital as follows: 40% debt, 15% preferred stock, and 45% common stock, the cost of capital is 7.64%

Cannibalization (Part 2 of 2)

Cannibalization is an aggressive business occurrence impacting many businesses. Essentially it is a process by which an entity establishes domineering market competition against itself in such a manner that the newly developed competition negates current sales of the pre-existing object. This often creates a loss for the entity wherein detriment is brought to cash flows that must considered appropriately and then accounted for as costs versus losses to better account for the business expenses against itself. These types of actions are not uncommon, can relate to an entire business entity, or product(s) within the organization and are all considered externalities. This term further purports the existence of an outside action that impacts the present and future potential of another in an attempt to remain relevant or to assume greater market share (Brigham, 2017). Unfortunately, this occurrence must be well managed otherwise the majority of projected profits could be negatively absorbed as losses. Yet, if approached constructively, cannibalization can yield profits far exceeding the losses in relation to the newer versus older product or business types.

Two corporations that have dealt with such cannibalization are Sprint and Samsung. While there are many business markets existing in both the negative and positive aspects of cannibalization, the communication market offers two similar but differing perspectives of functionally profitable externalities. Sprint deals in cannibalization because the push to close sales is critical to enhance market share. This is so because statistics support that “the number of mobile phone users in the world is expected to pass the five billion mark by 2019. The number of smartphone users is forecast to grow from 2.1 billion in 2016 to around 2.5 billion in 2019, with smartphone penetration rates increasing as well” (Unknown Author, N.D.). Because of this, as with most sales companies, the goal is to close the sale, but at what costs is the question. Society is centered within an age of rapid technology, so companies such as Sprint must sell now before someone offers something better later. The problem with that thereafter is that many customers lock into a payment contract that obligates them into the original purchase with little options to restructure a deal for a newer technological option set to urge Sprint into cannibalization of the product sales to the next best product idea.

One significant change Sprint made to undermine cannibalization was the implementation of a customer loyalty program. Humans are creatures of habit by nature and tend to find comfort in security and knowledge. This is facilitated by assurance and leads many consumers to remain with Sprint, to remain with a particular cell phone brand and to remain faithful to a service when there is comfort. One article suggested that nearly 81% of consumers admitted their preference to continue business ventures with a specific brand if they were loyalty program members (Marin, 2017). For this reason, amongst others, Sprint continues as a company with loyalty programs for its customers.

While there are many programs in use at this time, the cell phone upgrade loyalty program is one of their more significant and successful available. With this program, in this ever-changing technological world, iPhone subscribers are able to upgrade their cell phones to the latest iPhone within 12 to 18 months after the initiation of a monthly, pay over time, lease. The reason this qualifies as a relief to cannibalization is because

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