Nealon Energy Corporation engages in the? acquisition,exploration,? development, and production of natural gas and oil inthe continental United States. The company has grown rapidly overthe last 5 years as it has expanded into horizontal drillingtechniques for the development of the massive deposits of both gasand oil in shale formations. The? company's operations in theHaynesville shale? (located in northwest? Louisiana) have been sosignificant that it needs to construct a natural gas gathering andprocessing center near Bossier? City, Louisiana, at an estimatedcost of ?$60 million. To finance the new? facility, Nealon has ?$10million in profits that it will use to finance a portion of theexpansion and plans to sell a bond issue to raise the remaining?$50 million. The decision to use so much debt financing for theproject was largely due to the argument by company CEO DouglasNealon Sr. that debt financing is relatively cheap relative tocommon stock? (which the firm has used in the? past). Company CFODoug Nealon Jr.? (son of the company? founder) did not object tothe decision to use all debt but pondered the issue of what cost ofcapital to use for the expansion project. There was no doubt thatthe? out-of-pocket cost of financing was equal to the new interestthat must be paid on the debt.? However, the CFO also knew that byusing debt for this project the firm would eventually have to useequity in the future if it wanted to maintain the balance of debtand equity it had in its capital structure and not become overlydependent on borrowed funds. The following balance? sheet,LOADING...?, reflects the mix of capital sources that Nealon hasused in the past. Although the percentages would vary over? time,the firm tended to manage its capital structure back toward theseproportions. The firm currently has one issue of bonds outstanding.The bonds have a par value of ?$1,000 per? bond, carry a couponrate of 11 ?percent, have 15 years to? maturity, and are sellingfor ?$1,045. ?Nealon's common stock has a current market price of $41?, and the firm paid a ?$2.80 dividend last year that is expectedto increase at an annual rate of 4 percent for the foreseeablefuture.

SOURCE OF FINANCING	TARGET CAPITAL STRUCTURE WEIGHTS
Bonds	30?%
Common stock	70?%

a. What is the yield to maturity for? Nealon's bonds undercurrent market? conditions?

b. What is the cost of new debt financing to Nealon based oncurrent market prices after both taxes? (you may use a marginal taxrate of 35 percent for your? estimate) and flotation costs of ?$30per bond have been? considered? Note?: Use Nequals15 for the numberof years until the new bond matures.

c. What is the? investor's required rate of return for? Nealon'scommon? stock? If Nealon were to sell new shares of common? stock,it would incur a cost of ?$2.00 per share. What is your estimate ofthe cost of new equity financing raised from the sale of common?stock?

d. Compute the weighted average cost of capital for? Nealon'sinvestment using the weights reflected in the actual financing mix?(that is, ?$10 million in retained earnings and ?$50 million in?bonds).

e. Compute the weighted average cost of capital for Nealon wherethe firm maintains its target capital structure by reducing itsdebt offering to 30 percent of the ?$60 million in new? capital, or?$18 ?million, using ?$10 million in retained earnings and raising?$32 million through a new equity offering.

f. If you were the CFO for the? company, would you prefer to usethe calculation of the cost of capital in part ?(d?) or ?(e?) toevaluate the new? project? Why?