Juliett Artisans is evaluating a range of capital expenditure projects, requiring the firm to determine their marginal cost of capital. The firm’s current capital structure is deemed optimal, and consists of 32% long-term debt, 8% preferred stock, and 60% common equity. The firm’s marginal cost of capital is 30%.

The firm’s investment bankers believe Juliett Artisans can raise $120 million of debentures. Each $1,000 par value debenture will net the firm $987 after issuance costs, while offering investors a 5% annual coupon rate and 18 years till maturity. Beyond $120 million, the firm can raise additional debt from subordinated debentures, at a 1.5% higher after-tax cost. The issuance of new $2.60 preferred stock would also net Juliett Artisans $38.20 each after issuance costs.

Juliett Artisans recently paid a $1.10 per share dividend to common stockholders. The firm’s beta has recently fallen to 0.9. Earnings and dividends of the firm have been growing at 7% per annum over the past five years, however a 5% per annum growth rate is anticipated for the foreseeable future. Current yield offered on Treasury bills is 2% per annum, while the market risk premium is 8.5%. Net income is expected to be $81 million over the coming year. New shares could be sold to net Juliett Artisans $21.60 per share after issuance fees.

Required:

1. Calculate the break points associated with each source of capital.
2. Compute Juliett Artisans’ marginal cost of capital schedule.

Answer rating: 100% (QA)

Solution Break points Total new capital raised target weight ratio of capital Debt 118440000 Subordi... View the full answer