Problem 3 (30 points)

On January 1, 2010, the total assets of Dennis Corporation were $270 million. The firms present capital structure of 50% debt and 50% equity is considered optimal.

Dennis has the following options available to raise capital to fund its $135 million capital budget for the year:

• Bonds offering a 10% coupon, sold at par.
• Common Stock, market price of $60 per share with a $6 per share float cost.

Stockholders demand a 12% rate of return which consists of a dividend of 4% and an expected growth rate of 8%.

The next expected divided is $2.40.

• Dennis has $13.5 million of Retained Earnings at its disposal.

1. In order to maintain the current capital structure, how much of Denniss capital budget should be financed by equity? (4 pts)
2. How much of the new equity funds will be generated internally, and how much will be generated externally? (5 pts)
3. Using Denniss corporate tax rate of 40%, calculate the after-tax cost of each component of capital. (6 pts)

Kd=

Kre=

Kcs=

4. At what level of Denniss capital budget will a break occur? (4 pts)

BPre =

5. Calculate the weighted average costs of capital. (6 pts)

$ BRACKET FORMULA K_a

6. Draw and label a generic MCC / IOS schedule. Explain the use of plotting the MCC and IOS schedules to determine which projects to accept.(5 pts)