a. Calculate the cost of each source of financing, as specified: (1) Long-term debt, first $450,000. (2)

Question:

a. Calculate the cost of each source of financing, as specified:

(1) Long-term debt, first $450,000.

(2) Long-term debt, greater than $450,000.

(3) Preferred stock, all amounts.

(4) Common stock equity, first $1,500,000.

(5) Common stock equity, greater than $1,500,000.

b. Find the break points associated with each source of capital, and use them to specify each of the ranges of total new financing over which the firm's weighted average cost of capital (WACC) remains constant.

c. Calculate the weighted average cost of capital (WACC) over each of the ranges of total new financing specified in part b.

d. Using your findings in part c along with the investment opportunities schedule (IOS), draw the firm's weighted marginal cost of capital (WMCC) and IOS on the same set of axes (total new financing or investment on the x axis and weighted average cost of capital and IRR on the y axis).

e. Which, if any, of the available investments would you recommend that the firm accept? Explain your answer.

Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter (OTC) market. During 2009, the Dallas-based company experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa Jen, the company''s treasurer, wants to make sure that available funds are being used to their fullest. Management policy is to maintain the current capital structure proportions of 30% Long-term debt, 10% preâ€” ferred stock) and 60% common stock equity for at least the next 3 years. The firm is in the 40% tax bracket.

Star's division and product managers have presented several competing investment opportunities to Jen. However because funds are limited, choices of which projects to accept must be made. The investment opportunities schedule (IOS) is shown in the table on page 540.

a. Calculate the cost of each source of financing, as

To estimate the firm's weighted average cost of capital (WACC), Jen contacted a leading investment banking firm, which provided the financing cost data shown in the following.
Long-term debt: The firm can raise $450,000 of additional debt by selling 15-year, $1,000-par-value, 9% coupon interest rate bonds that pay annual interest. It expects to net $960 per bond after flotation costs. Any debt in excess of $450,000 will have a before-tax cost, rd, of 13%.
Preferred stock, regardless of the amount sold, can be issued with a $70 par value and a 14% annual dividend rate and will net $65 per share after flotation costs.
Common stock equity: The firm expects dividends and earnings per share to be $0.96 and $3.20, respectively, in 2010 and to continue to grow at a constant rate of 11 % per year. The firm's stock currently sells for $12 per share. Star expects to have $1,500,000 of retained earnings available in the coming year. Once the retained earnings have been exhausted, the firm can raise additional funds by selling new common stock, netting $9 per share after underpricing and flotation costs.

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... 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... 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... 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,...