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MGT 325 Module 5 Spreadsheet Exam - this is one long problem

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MGT 325 Module 5 Spreadsheet Exam - this is one long problem or case

To do this exam you need to study the cases at the end of Chapter 11. Remember that the cost of debt when calculated is before tax and has to be converted to an after tax return. The returns on preferred and common stock are already after tax so are not adjusted which is in Chapter 10.

PROBLEM FOR CHAPTERS TEN AND ELEVEN Saint Leo Manufacturing is going to introduce a new product line and to accomplish this it has four projects analyzed in which it wants to invest a total of $100 million. Your job is to find what it will cost to raise this amount of capital and based on the cost of capital determine which of the projects should be accepted by the firm to invest in.

PROJECTS A B C D INVESTMENT $30,000,000 $20,000,000 $25,000,000 $25,000,000 EXPECTED RETURN 10.00% 14.00% 11.50% 16.00%

The firms capital structure consists of: FMV CAPITAL PERCENTAGE AMOUNT DEBT 30% $15,000,000 PREFERRED STOCK 10% $5,000,000 COMMON STOCK 60% $30,000,000 $50,000,000 Other information about the firm: CORPORATE TAX RATE 30% DEBT CURRENT PRICE $1,050.00 ANNUAL INTEREST 6.00% CURRENT INTEREST PAID SEMIANNUALLY ORIGINAL MATURITY 25 YEARS, BUT NOW 20 YEARS LEFT MATURITY VALUE $1,000.00 FLOTATION COST INSIGNIFICANT MARKET YIELD PROJECTED: UP TO $20 MILLION 9% ABOVE $20 MILLION 12% 3 % additional premium

PREFERRED CURRENT PRICE $45.00 LAST DIVIDEND (D0) $3.38 FIXED AT 7.5% OF PAR FLOTATION COST $1.50 NEXT DIVIDEND (D1) $3.38

COMMON CURRENT PRICE $35.00 LAST DIVIDEND (D0) $1.00 RETAINED EARNINGS $10,000,000 GROWTH RATE (g) 9% FLOTATION COST $1.50 NEXT DIVIDEND (D1) $1.090

NOTE - Once retained earnings is maxed out new common stock will need to be issued. Any preferred stock would be new preferred stock. You may want to review case in chapter 11.

REQUIRED:

In all of the required parts one part builds on the previous part. If you can't do a part use the set of other numbers to solve the next part. a. What is the current Kd, Kp and Ke assuming no new debt or stock? b. Since any new capital investment will require issuing new perferred stock, what would the the new returns be preferred stock (knp) and the new cost of capital? c. What amount of increase (marginal cost of capital) in capital structure will the firm run out of retained earnings and be forced to issue new common stock? d. If new common stock has to be issued what will the new return required be (Kne) and the new cost of capital?

Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.

Part a Current price Maturity value Interest payment Payment periods Yield rate six month rate Annual yield annual rate Kd Kp Ke Current Cost of capital

Can't really use the current cost of capital since accepting any new projects will require issuing new Preferred stock requiring a rate higher than its current 7.5% yield.

Part b Use your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%; = Knp preferred stock New cost of capital

Part c If the capital structure increases more than new common stock will have to be issued to finance new projects since internally generated RE runs out, and the required return on common stock will increase as demanded by shareholders.

Part d Kne common stock If you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%= New cost of capital

Please note that I will get paid for my work only after you accept the answer. So, kindly ACCEPT the answer by clicking at Green button, so that I get paid for my work.

Looks good, but some of it is confusing me..not sure the formulas off to the right are, and some of the questions (i.e yield rate (six months)) are missing from your spreadsheet.

This formula calculates weighted average cost of capital. A company's capital structure is made up of debt, preferential shares, and common equity. The cost of debt, cost of pref. share and cost od equity are not same. So, to arrive at WACC, we multiply weight of each of the component of capital structure and its cost, then we add all three. WACC= weight of debt*cost of debt + weight of pref share*cost of pref share + weight of equity*cost of equity

here, one thing should be noted. Cost of debt is after tax cost as debt gives tax shield on interest payment. So, Kd = pretax cost of debt*(1-Tax rate) In our example, we calculated YTM, which is pretax cost of debt. After tax cost of debt is calculated as YTM*(1-T)

Can I ask you a quick question...In Part C on the worksheet the question is..

If the capital structure increases more than new common stock will have to be issuesed to finance new projects since internally generated RE runs out, and the required return on common stock will increase as demanded by shareholders.

Your response in the spreadsheet you sent gave me three things, do I need all three for the answer of this question. Or do I need to input all three in the answer and why?

Sorry for late response. As we are in different time zone, when you posted the query, it was late night here. common stock is 60% of capital structure. So, new equity has to be issued when capital structure increases more than 60% of the retained earning. Retained earning is 10,000,000. So, new stock has to be issued when capital structure increases more than 10,000,000/60% = $16,666,667.