Question A
In this question, the focus is on the computation of the cost of capital. The dividend on the common equity is taken to be the only form of return to common stock and hence, the dividends are divided with the price and converted to percentage to get return on common stock. Nevertheless, due to growth, dividends are multiplied by annual growth rate ( Jorg, 2018) . The same approach is employed on debt where coupon is taken to be the cost of debt. Nevertheless, the tax portion is deducted since use of debt in the capital structure provides the entity with tax advantage. Then eventual cost of capital is as presented in the table below
| Weighted cost of capital | ||||
| A. Cost of capital | ||||
| Cost of capital = | cost of equity* weight of equity + | |||
| cost of preferred stock * cost of preferred stock of debt | ||||
| + cost of debt * weight | ||||
| Cost of debt | Coupon rate of bond (Debt*(1-tax of 35%) |
5% |
||
| cost of preferred stock | Preferred stock rate (2.5/25) |
10% |
||
| cost of common equity | common stock (1.5*1.05)/20) |
7.90% |
||
| Cost of capital | ||||
| Ks*Ws+Kp*Wp+Kd+Wd | ||||
| (0.79*0.5)+(0.1*0.05)+(0.05*0.45) |
6.70% |
|||
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Question B
In this particular question, computations are largely similar to the ones provided in question A. Nevertheless, capital weighting has changed. The computations are as indicated in the diagram below
| Ks | Kp | Kd | ||
| 0.079 | 0.1 | 0.05 | ||
| Ws | Wp | Wd | ||
| 0.65 | 0.05 | 0.3 | ||
| Cost of capital = (0.079*0.65)+(0.1*0.05)+(0.05*0.3) |
7.14% |
|||
| Abbreviations | ||||
| Ks: cost of equity | Kp: Cost ofpreferred stock | |||
| Kd: Cost of debt | Ws: Weight of equity | |||
| Wp: Weight of Preferred stock | Wd: Weight of debt | |||
From the above computations, it is clear that organizations depend on different forms of capital to finance their operations. Equity capital may be inform of the common stock or the preferred stock. The common stock is issued to the shareholders in the market. They are also traded in the stock market ( Grabowski, Nunes, & Harrington, 2017) . They have no fixed earnings as compared to the preferred stock. On the other hand, the debt may be inform of bank loans or bonds issued to the investors in the market. Such bonds may have coupon payments or not. In this particular study, the bond has coupon payments which are taken to be the cost of debt.
C.
This section focuses on cannibalization in the market. Market cannibalization refers to negative impact of a company new product on the sales of its already existing customers. This was evident in Coca-Cola Company when it developed the diet coke (Investopedia, 2018). It tasted better than its century old coke, something that resulted in customers shifting from its traditional coke to the new product. This led to the rise of the sales of the new product as the price of its traditionally recognized coke declined. Another case of cannibalism is evident in the case of Wal-Mart. Wal-Mart is a giant retail outlet in the United States of America (TBP, 2018). By establishing smaller stores near its superstores, it implies that the organization will lose some of the customers who have been shopping from its supercenters. Market cannibalism has the potential of resulting in loss of market for an organization’s products. Then market cannibalism in the case of Coca-Cola and Wal-Mart will have an adverse effect on the market of their products. In an industry, companies lose their market share to the competing firms. Cannibalism acts in the same manner to the organization’s market share. It results in the entity losing market share of its existing products.
References
Grabowski, R. J., Nunes, C., & Harrington, J. P. (2017). 2017 valuation handbook: International industry cost of capital .. Hoboken, New Jersey
Jorg, W. (2018). funktionaleschadensbewertung .UK: Springer Gabler.
TBP (2018). Wal-Mart not concerned about cannibalization with small store expansion. Retrieved from https://talkbusiness.net/2014/06/wal-mart-not-concerned-about-cannibalization-with-small-store-expansion/
Investopedia (2018). What is market cannibalization. Retrieved from https://www.investopedia.com/ask/answers/08/market-cannibalization-coke-cola-wars.asp
