Davola Inc. has the following financial information: • Debt: The firm issued 1,000, 20 year bonds...

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Finance

Davola Inc. has the following financial information: • Debt: Thefirm issued 1,000, 20 year bonds five years ago which were sold ata par value of $1,000. The bonds carry a coupon rate of 8.4%. •Preferred Stock: Pays a 9.75% preferred dividend with a par of $100and is currently selling for $86. • Equity: Davola’s common stockcurrently sells for $72 and grows at a constant rate of 6%. Davolajust paid a $4.65 dividend to their shareholders. • Davola’sbusiness plan for next year projects net income of $360,000, halfof which will be retained. • The company applies an average taxrate of 35% for cost of capital decision-making purposes. • DovolaInc. pays flotation costs of 10% on all new stock issues. •Dovola’s capital structure is 40% debt, 15% preferred stock and 45%common equity.
a. Compute the capital component costsfor each of the capital components. Ignore flotation costs for debtand preferred stock.
b.   Calculate the WACCbefore the break in retained earnings.
c.   Calculate Davola’sbreak point in retained earnings.
d.   Calculate the WACCafter the break in retained earnings. In otherwords, calculate the WACC given the           pointthat the firm will have to issue new stock to fund the equityportion of its capital budget.

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4.4 Ratings (974 Votes)

1 Cost of Debt 840 Because the Bonds are Selling at Par the cost of debt will be equal to Coupon rate Cost of Preferred Stock Dividend Preferred Dividend Market Price 100 975 86 1134 Cost of Common Stock Dividend in See Answer

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Davola Inc. has the following financial information: • Debt: Thefirm issued 1,000, 20 year bonds five years ago which were sold ata par value of $1,000. The bonds carry a coupon rate of 8.4%. •Preferred Stock: Pays a 9.75% preferred dividend with a par of $100and is currently selling for $86. • Equity: Davola’s common stockcurrently sells for $72 and grows at a constant rate of 6%. Davolajust paid a $4.65 dividend to their shareholders. • Davola’sbusiness plan for next year projects net income of $360,000, halfof which will be retained. • The company applies an average taxrate of 35% for cost of capital decision-making purposes. • DovolaInc. pays flotation costs of 10% on all new stock issues. •Dovola’s capital structure is 40% debt, 15% preferred stock and 45%common equity.a. Compute the capital component costsfor each of the capital components. Ignore flotation costs for debtand preferred stock.b. Calculate the WACCbefore the break in retained earnings.c. Calculate Davola’sbreak point in retained earnings.d. Calculate the WACCafter the break in retained earnings. In otherwords, calculate the WACC given the pointthat the firm will have to issue new stock to fund the equityportion of its capital budget.