| Course | ACC-7020 Financial Essentials for Accountants |
|---|---|
| Module | Module 2 |
| Paper type | Module 2 written assignment: capitalization techniques |
| Length | About 735 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | MBA in Accounting |
| Updated | October 2026 |
Free sample paper for ACC 7020 Module 2
What Ridgeline's Capital Costs: Bond Prices, the Cost of Equity and a Weighted Average for a Packaging Company
Student Name
MBA in Accounting, Thomas Edison State University
ACC-7020: Financial Essentials for Accountants
Mentor Name
Month Day, Year
What Ridgeline's Capital Costs: Bond Prices, the Cost of Equity and a Weighted Average for a Packaging Company
Introduction
A company's capital comes from lenders and shareholders, each requiring a return that reflects risk. Bond values move inversely with market interest rates, and the cost of equity is not observed directly but inferred from models. The weighted average cost of capital combines these costs at target weights and serves as the discount rate for average-risk projects (Ehrhardt & Brigham, 2024).
Part A: Valuing the Bonds
Each Ridgeline bond pays a 5.5 percent coupon on $1,000 in two installments a year and matures in ten years. Similar bonds now yield 6.4 percent.
Each price discounts 20 semiannual coupons of $27.50 and the face value at half the market yield, 3.2 percent per period at 6.4 percent. The bond sells at a discount because its coupon is below the market yield. A one-point change in rates moves its price by about 7 to 8 percent, with a larger gain when rates fall than loss when they rise, the asymmetry known as convexity. Longer maturities and lower coupons would increase this sensitivity.
| Market yield | Bond price | Change from $934.27 |
|---|---|---|
| 5.4 percent | $1,007.65 | +7.9% |
| 6.4 percent | $934.27 | None |
| 7.4 percent | $867.39 | -7.2% |
The Call Provision
The bonds are callable after five years at $1,027.50. A call lets Ridgeline refinance if rates fall, which harms investors, who would be repaid when reinvestment rates are low. Investors therefore demand a higher yield on callable bonds, and when a bond trades above its call price, yield to call rather than yield to maturity is the relevant return. At current prices the call is unlikely, so yield to maturity applies.
Part B: The Cost of Equity Two Ways
The two estimates differ by about half a point, which is normal; each rests on uncertain inputs, beta and the market premium in one case and long-run growth in the other. The CAPM estimate is used here because Ridgeline's growth forecast is less reliable than its measured beta, and because Graham and Harvey (2001) found that most companies rely on CAPM.
A third check, the bond yield plus risk premium approach, adds a judgmental premium of 3 to 5 points to the company's own 6.4 percent bond yield, giving a range of 9.4 to 11.4 percent, which brackets both estimates.
| Method | Inputs | Cost of equity |
|---|---|---|
| Capital asset pricing model | 4.2% risk-free rate + 1.15 beta x 5.5% market risk premium | 10.53% |
| Dividend growth model | $2.10 expected dividend / $52 price + 6% growth | 10.04% |
Part C: The Weighted Average Cost of Capital
The weights are targets at market values rather than book figures, since the return lenders and shareholders demand is earned on what their claims are worth today. If Ridgeline had to issue new stock, flotation costs would raise the cost of new equity above 10.53 percent, which is one reason companies prefer retained earnings.
The WACC applies only to projects as risky as the company's existing business. A project with higher risk, such as a new product line, should be evaluated at a higher rate, and a project with lower risk, such as replacing existing equipment, at a lower one. Module 3 applies this idea by adding a risk premium to the WACC for a new recyclable fiber line.
| Source | Target weight | After-tax cost | Weighted cost |
|---|---|---|---|
| Debt | 35% | 6.4% x 0.75 = 4.80% | 1.68% |
| Common equity | 65% | 10.53% | 6.84% |
| WACC | | | 8.52% |
Part D: Should Ridgeline Use More Debt?
The CFO proposes raising debt to 45 percent of capital to fund buybacks. With taxes, debt adds value through the interest tax shield, but beyond some point expected costs of financial distress outweigh it. At 45 percent debt, Ridgeline's bond rating would likely fall from BBB to BB, raising its pretax cost of debt to about 7.6 percent, and its beta would rise to about 1.32, lifting the cost of equity to about 11.5 percent. The WACC would then be about 0.45 times 5.7 percent plus 0.55 times 11.5 percent, roughly 8.9 percent, higher than today. Myers (1984) adds that firms prefer internal funds, then debt, then equity, which explains why many profitable firms carry less debt than the trade-off theory predicts. Because the higher WACC would lower firm value, and the buyback would serve the EPS bonus examined in Module 1 more than shareholders, the controller should advise keeping debt near 35 percent.
References
Ehrhardt, M. C., & Brigham, E. F. (2024). Corporate finance: A focused approach (8th ed.). Cengage Learning.
Graham, J. R., & Harvey, C. R. (2001). The theory and practice of corporate finance: Evidence from the field. Journal of Financial Economics, 60(2-3), 187-243. https://doi.org/10.1016/S0304-405X(01)00044-7
Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39(3), 574-592. https://doi.org/10.1111/j.1540-6261.1984.tb03646.x
ACC 7020 Module 2 instructions, in plain terms
The second assignment prices each source of Ridgeline's capital and weighs a change in its mix, the decision its CFO has put to the board. Expect problems that value bonds, compute yields to maturity and to call, explain interest rate and reinvestment risk, value stock with the dividend growth model, estimate component costs of capital, compute the WACC with market value weights and discuss capital structure theory and the effects of borrowing more. Bond terms and market rates here are illustrative. Expect semiannual bond problems and at least one question on how added debt changes the cost of capital. Some versions add preferred stock to the WACC or ask for the yield to call on a premium bond.
How the ACC 7020 Module 2 example is put together
The introduction explains why each source of capital has a cost and how the WACC is used. Part A values the bond at three yields in a table, explains discount pricing and convexity and discusses the call provision. Part B estimates the cost of equity with two models and justifies the choice with survey evidence. Part C builds the WACC with market weights and notes flotation costs. Part D evaluates heavier borrowing by recomputing the WACC with higher component costs, applies trade-off and pecking order theory and connects the decision to the bonus incentive from Module 1. The bond table shows convexity directly, and the debt analysis recomputes every cost rather than holding them fixed.
Where the marks sit in the ACC 7020 Module 2 rubric
Capitalization problems sit among the heavier written assignments, worth about 9 points. Mentors check bond prices and yields, correct component costs, after-tax debt cost, market value weights and the WACC, plus discussion of capital structure that applies theory to the company. Comparing estimates and explaining judgment shows mastery. Clear tables with formulas earn partial credit when numbers slip. Mentors want to see each component cost derived, not assumed, and the debt discussion supported by recomputed component costs rather than assertion. Bond prices should be computed with semiannual periods and checked against the yield. Using a third method to bracket the cost of equity strengthens the analysis.
ACC 7020 Module 2 help from the desk
Capitalization answers lose points for using annual instead of semiannual periods, forgetting the tax adjustment to debt, using book weights and treating more debt as always cheaper. Match periods to coupon frequency. Use market weights. When debt changes, recompute both component costs before comparing WACCs. Write the number of periods and the periodic rate beside every bond computation. When estimating the cost of equity, compare two methods and explain which you trust more. A new debt level means new component costs, so recompute both before comparing. Use market weights, not book weights. A free first sample of your own ACC-7020 Module 2 problems is available on request.
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ACC 7020 Module 2 questions, answered
Where can I find a free ACC 7020 Module 2 sample paper?
Ridgeline's capital costs are worked above: bond prices at three yields, two cost of equity estimates, the WACC and a borrowing decision.
Why do bond prices fall when interest rates rise?
Fixed coupons become less attractive than new bonds at higher rates, so the price adjusts until the yield matches the market.
Why is the cost of debt adjusted for taxes?
Interest lowers taxable income, so debt's true cost is its rate after the tax saving.
Why use market value weights in the WACC?
Because investors' required returns apply to the current market value of their claims, not historical book amounts.
Does more debt always lower the WACC?
No. Beyond a point, higher costs of debt and equity from financial risk raise the WACC.