On January 1, the total market value of the Tysseland Company was $60 million. During the year,

Question:

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The firm’s present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt.

Debt $30,000,000

Common equity 30,000,000

Total capital $60,000,000

New bonds will have an 8 percent coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. Stockholders’ required rate of return is estimated to be 12 percent, consisting of a dividend yield of 4 percent and an expected constant growth rate of 8 percent. (The next expected dividend is $1.20, so $1.20/$30 _ 4%.) The marginal corporate tax rate is 40 percent.

a. To maintain the present capital structure, how much of the new investment must be financed by common equity?

b. Assume that there is sufficient cash flow such that Tysseland can maintain its target capital structure without issuing additional shares of equity. What is the WACC?

c. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC?

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... Bonds
When companies need to raise money, issuing bonds is one way to do it. A bond functions as a loan between an investor and a corporation. The investor agrees to give the corporation a specific amount of money for a specific period of time in exchange... 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... 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...