Richmond Inc.'s after-tax weighted marginal cost of capital for the two alternatives is: Alternative. After-tax cost. We
Richmond - WACC
1&2. Richmond Inc.’s after-tax weighted marginal cost of capital for the two alternatives is: Alternative
After-tax cost
Weight
Marginal cost
6.60%
100%
6.60%
5.4%
40%
2.16%
7.37%
15%
1.11%
17.16%
30%
5.15%
16.60%
15%
2.49%
Pure debt Bonds .11 x (1 - .40) Combination Bonds
.09 x (1 - .40)
Pref Sh .07 ÷ (1 - .05) Common Shares
(1)
Retained Earnings
(2)
Weighted marginal cost (1)
{($3 x 1.06) ÷ [$30 x (1.-05)]} + .06
(2)
[($3 x 1.06) ÷ 30] + .06
10.91%
3. The combination alternative would maintain the present capital structure that is considered optimal for retailing. The pure debt alternative results in a less than optimal capital structure. The increased portion of the firm financed by debt would increase the firm’s default risk and thus increase the return required by the firm’s investors. i.e., bond investors would require a greater risk premium in the pure debt alternative than in the combination alternative. 4. Linda Perlman has violated the standards contained in the IMA Statement Of Ethical Professional Practice: Competence • •
Perform professional duties in accordance with relevant laws, regulations, and technical standards. Provide decision support information and recommendations that are accurate, clear, concise, and timely.
By including the obsolete inventory, Perlman would not be preparing an accurate report using reliable information; also GAAP requires the write down of inventory. Integrity • •
Mitigate actual conflicts of interest, regularly communicate with business associates to avoid apparent conflicts of interest. Advise all parties of any potential conflicts. Abstain from engaging in or supporting any activity that might discredit the profession.
Members of the management team, of which Perlman is a part, are responsible for both operations and recording the results of operations. Because the team will benefit from a bonus, increasing earnings by ignoring the obsolete inventory is clearly a conflict of
Richmond - WACC
interest. Perlman would also be concealing unfavorable information and subverting the goals of the organization. Furthermore, such behavior is a discredit to the profession. Credibility • •
Communicate information fairly and objectively. Disclose all relevant information that could reasonably be expected to influence an intended user's understanding of the reports, analyses, or recommendations.
Hiding the obsolete inventory impairs the objectivity and relevance of the financial statements.
