A. 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 8% and to issue new preferred stock with a $2.50 per share
dividend at $25 a share. The common stock of Bad Boys, Inc. is currently selling for $20.00 a share.
Bad Boys, Inc. expects to pay a dividend of $1.50 per share next year. An equity analyst foresees
a growth in dividends at a rate of 5% per year. Bad Boys, Inc. marginal tax rate is 35%. If Bad Boys,
Inc. raises capital using 45% debt, 5% preferred stock, and 50% common stock, what is Bad Boys
cost of capital?

Answer: As the instructions are given we have to calculate cost of capital or weighted average cost of
capital (WACC) so the formula for calculating the cost of capita is given below;

𝑊𝐴𝐶𝐶 = 𝑟𝑠 ∗ 𝑊𝑠 + 𝑟𝑑 ∗ 𝑊𝑑 ∗ (1 − 𝑇) + 𝑟𝑝 ∗ 𝑊𝑝

Where;

 rs is cost of equity
 𝑊𝑠 is weight of common stock,
 rd is cost of debt,
 𝑊𝑑 is weight of common stock
 rp is cost of preferred Stock,
 𝑊𝑝 is weight of common stock
 𝑇 is the marginal tax rate

Data and some necessary calculation

𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 1.5
 𝑟𝑠 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑃𝑟𝑖𝑐𝑒
+ 𝐺𝑟𝑜𝑤𝑡ℎ 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 = 20
+ 5% = 12.5. %
 𝑊𝑠 = 50%
 rd = 8%
 𝑊𝑑 = 45%
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑜𝑛 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 2.5
 𝑟𝑝 = = = 10%
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑃𝑟𝑒𝑓𝑒𝑟𝑟𝑒𝑑 𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒 25
 𝑊𝑝 = 5%
 𝑇 = 35%
𝑊𝐴𝐶𝐶 = (0.125) ∗ (0.50) + (0.08) ∗ (0.45) ∗ (1 − 0.35) + (0.10) ∗ (0.05)
𝑊𝐴𝐶𝐶 = 0.0625 + 0.0234 + 0.005
𝑊𝐴𝐶𝐶 = 0.0909 = 9.09%
On average, as the cost of total capital raised through a combination of debt, preferred equity and
common equity, Bad boys pays about 9.09% percent per annum. As the some of the date was not given
directly so I have calculated rs and rp first as the requirement of WACC formula by using some formulas
is described above we reached at conclusion. On average Bad boys Inc. uses 9.09% cost for using given
capital structure. Generally company always needs minimum cost to pay on its capital structure.
 B. If Bad Boys, Inc. raises capital using 30% debt, 5% preferred stock, and 65% common stock, what
is Bad Boys cost of capital?

Answer:

As in this part all the value are same as in part A except capital structure

 𝑊𝑠 = 65%
 𝑊𝑑 = 30%
 𝑊𝑝 = 5%
 rs = 12.5%
 rd = 8%
 𝑟𝑝 = 10%
 𝑇 = 35%
𝑊𝐴𝐶𝐶 = (0.125) ∗ (0.65) + (0.08) ∗ (0.35) ∗ (1 − 0.35) + (0.10) ∗ (0.05)
𝑊𝐴𝐶𝐶 = 0.08125 + 0.0182 + 0.005
𝑊𝐴𝐶𝐶 = 0.1045 = 10.45%

On average, as the cost of total capital raised through a combination of debt, preferred equity and
common equity the weight is 35%, 5% and 65% respectively, Bad boys pays about 9.09% percent per
annum.

C. On page 457, your textbook details the term Cannibalization. In your own words, identify two
corporations that have dealt with cannibalization and what steps were taken to overcome the
cannibalization. Please provide any citations and references. Please be articulate in your
responses.

Answer:

Cannibalize is the process of launching new products, with reference to their own available products.
Cannibalization can be define as when company introduces its new product bases a decline in the sales of
company’s existing product in current market.

One the well-known cannibalization done by Coca-Cola when it introduced different flavored products
against its existing well-known product Coke (Business Insider, 2017). This was done to acquire more
market share in the beverage industry, main reason was to produce different flavored products to give
different taste to its existing customers. When Coca Cola launched different Coke flavors e.g. Diet and the
existing Coke lost market share to Coke Diet. Overall, new product by Coke attracted more share from
Pepsi, therefore Coca-Cola was the winner in the end. Steps taken by Coke are given blow;

 Coke first identified its existing customers of their existing product.

 Coke then identifies their potential customers for new product.
 Then coke launched it new flavored products in the market.
Apple launched iPhone that includes iPod features and then launched its semi-annual product launches
introducing iPhone 4S within one year of iPhone 4 launch (insider, 2015). One of the business rules,
according to Steve Jobs ' interview with Walter Isaacson, “was never to be afraid to cannibalize yourself,
if you don’t cannibalize yourself, someone else will,” he said (Harvard Business Review, 2012). Although
an advanced iPhone 4S could cannibalize an iPhone 4's sales, it didn't dissuade him.

References:

Insider, B. (2017) from https://www.businessinsider.com/apple-on-cannibalization-2015-12

Review, H.B. (2012) from https://hbr.org/2012/04/the-real-leadership-lessons-of-steve-jobs

insider, B. (2015). from https://www.businessinsider.com/apple-on-cannibalization-2015-12