Nealon Energy Corporation engages in the acquisition, exploration, development, and production of natural gas and oil in
Question:
SOURCE OF FINANCING TARGET CAPITAL STRUCTURE WEIGHTS
Bonds...................... 40%
Common Stock................... 60%
The firm currently has one issue of bonds outstanding. The bonds have a par value of $ 1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity, and are selling for $ 1,035. Nealon’s common stock has a current market price of $ 35 and the firm paid a $ 2.50 dividend last year that is expected to increase at an annual rate of 6 percent for the foreseeable future.
a. What is the yield to maturity for Nealon’s bonds under current market conditions?
b. What is the cost of new debt financing to Nealon based on current market prices after both taxes ( you may use a 34 percent marginal tax rate for your estimate) and flotation costs of $ 30 per bond have been considered?
c. What is the investor’s required rate of return for Nealon’s common 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 of the cost of new equity financing raised from the sale of common stock?
d. Compute the weighted average cost of capital for Nealon’s investment using the weights reflected in the actual financing mix (that is, $ 20 million in retained earnings and $ 50 million in bonds).
e. Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the $ 70 million in new capital, or $ 28 million, using $ 20 million in retained earnings and raising $ 22 million through a new equity offering.
f. If you were the CFO for the company, would you prefer to use the calculation of the cost of capital in part (d) or (e) to evaluate the new project? Why?
Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Balance Sheet
Balance sheet is a statement of the financial position of a business that list all the assets, liabilities, and owner’s equity and shareholder’s equity at a particular point of time. A balance sheet is also called as a “statement of financial... Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a... Corporation
A Corporation is a legal form of business that is separate from its owner. In other words, a corporation is a business or organization formed by a group of people, and its right and liabilities separate from those of the individuals involved. It may... Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Coupon
A coupon or coupon payment is the annual interest rate paid on a bond, expressed as a percentage of the face value and paid from issue date until maturity. Coupons are usually referred to in terms of the coupon rate (the sum of coupons paid in a... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Maturity
Maturity is the date on which the life of a transaction or financial instrument ends, after which it must either be renewed, or it will cease to exist. The term is commonly used for deposits, foreign exchange spot, and forward transactions, interest... Par Value
Par value is the face value of a bond. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. The market price of a bond may be above or below par,...
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Related Book For
Foundations of Finance The Logic and Practice of Financial Management
ISBN: 978-0132994873
8th edition
Authors: Arthur J. Keown, John D. Martin, J. William Petty
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