Rolodex, Inc., is in the process of determining its capital budget for the next fiscal year. The firms current capital structure, which it considers to be optimal, is contained in the following balance sheet:

Discussions between the firms financial officers and the firms investment and commercial bankers have yielded the following information:
Rolodex can borrow $40 million from its bank at a pretax cost of 13 percent.
Rolodex can borrow $80 million by issuing bonds at a net price of $687 per bond.
The bonds would carry a 10 percent coupon rate and mature in 20 years.
Additional debt can be issued at a 16 percent pretax cost.
Preferred stock can be issued at a pretax cost of 16.5 percent.
Rolodex expects to generate $140 million in net income and pay $2 per share in dividends.
The $2 per share dividend (D1) represents a growth of 5.5 percent over the previous years dividend. This growth rate is expected to continue for the foreseeable future. The firms stock currently is trading at $16 per share.
Rolodex can raise external equity by selling common stock at a net price of $15 per share.
Rolodexs marginal tax rate is 40 percent.
a. Compute Rolodexs marginal cost of capital schedule.
b. Given the following investment opportunity schedule, determine Rolodexs optimal capital budget.

Transcribed Image Text:

Rolodex, Inc., Balance Sheet (In Millions of Dollars Current assets Fixed assets Total assets $ 30 20 128 32 $10 Accounts payable 260 Other current liabilities $30 Long-term debt Preferred stock Common stock (20 millon shares at par) Contributed capital In excess of par Retalned eanings 20 30 L1Q $370 Total lablities and equity Required Investment $140,000,000 130,000,000 00,000,000 80,000,000 24,000,000 16,000,000 Expected Return on Project 17.0% 16.0 15.0 14.2 13.0 10.9 roject