18. You are evaluating next year investment opportunities and your company cost of capital. You anticipate...

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Finance

18. You are evaluating next year investment opportunities andyour company cost of capital. You anticipate that if you couldminimize your cost, more feasible projects could be undertaken. Youare also able to determine your capital budget for next year.Opportunities available are as follows:
Projects Rate of Return
A 13%
B 12%
C 15%
D 14%
E 11%
You believe your current capital structure is optimal and evenif you would have to raise new funds, this proportion will bemaintained:
LT Debts 50% Pref. Stock 10% Com. Stock 40%
Your company can issue unlimited amount of 9% semi-annual couponbond with 10 years maturity period. Bonds will be issued at par buta 2.5% flotation cost will be incurred.
You can sell new 9% $100 par value preferred stock for $95 pershare. Flotation cost is $10 per share.
Forthcoming dividend is expected to be $1.25, dividend expectedto grow at a constant rate of 4% and common shares is selling for$11. The company expects $320,000 in retained earnings and cost ofissuing new common stock is $1.00. Your tax rate is 40%.
Which investment/s, if any, would you recommend? Use theWMCC/IOS to explain.
(Hint: Determine the following: Cost of capital components;Breakpoints; WACC at various level of breakpoints; Projectsaccepted and total amount of capital budget; WACC for the planningperiod)

Answer & Explanation Solved by verified expert

3.9 Ratings (593 Votes)

The cost of capital is comprised of the costs of debt preferred stock and common stock The formula for the cost of capital is comprised of separate calculations for all three of these items which must then be combined to derive the total cost of See Answer

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18. You are evaluating next year investment opportunities andyour company cost of capital. You anticipate that if you couldminimize your cost, more feasible projects could be undertaken. Youare also able to determine your capital budget for next year.Opportunities available are as follows:Projects Rate of ReturnA 13%B 12%C 15%D 14%E 11%You believe your current capital structure is optimal and evenif you would have to raise new funds, this proportion will bemaintained:LT Debts 50% Pref. Stock 10% Com. Stock 40%Your company can issue unlimited amount of 9% semi-annual couponbond with 10 years maturity period. Bonds will be issued at par buta 2.5% flotation cost will be incurred.You can sell new 9% $100 par value preferred stock for $95 pershare. Flotation cost is $10 per share.Forthcoming dividend is expected to be $1.25, dividend expectedto grow at a constant rate of 4% and common shares is selling for$11. The company expects $320,000 in retained earnings and cost ofissuing new common stock is $1.00. Your tax rate is 40%.Which investment/s, if any, would you recommend? Use theWMCC/IOS to explain.(Hint: Determine the following: Cost of capital components;Breakpoints; WACC at various level of breakpoints; Projectsaccepted and total amount of capital budget; WACC for the planningperiod)