Question 2 (16 marks) Network engineers at ORANO Networking Solutions (ONS) have developed a plan to upgrade the design of the company's line of routers and switches that will improve performance and throughput. The design team is ready to proceed with the implementation of the plan and is requesting $5 000 000 from the company's capital budget. Economic analysis on the team's project proposal has determined a rate of return on investment of 9.4%. ONS would raise the required funding by using a debt ratio of 30%. The vice president of finance says that experience has shown that this is the optimal capital structure for ONS. The VP's plan for raising the required funding is as follows: 1. $300 000 would be borrowed from the company's bank at an annual rate of 4%. 2. The remainder of the debt would be raised by selling bonds which would pay bondholders 7% per year. 3. The equity portion of the financing would be raised by selling shares to new investors. Shares are currently trading at $50.00 which should return 12% per year to shareholders. (a) How many shares should ORANO Networking Solutions sell and what is the total value of the bonds that should be issued? [4] (b) Should ONS go ahead with this project? Justify your recommendation. [5] (c) What does it mean for a 30% debt ratio to represent the optimal capital structure? Be sure to discuss how the cost of capital would vary, and why, if ONS did not use the proposed 30% debt ratio to potentially finance this project. Be sure to use an appropriate graph of the cost of capital to help explain your answer. [7] Question 2 (a) 70 000 shares; $1 200 000 bonds. (b) Reject the capital budget request as the project return is less than cost of capital (9.4% vs. 10.3%). Question 2 (16 marks) Network engineers at ORANO Networking Solutions (ONS) have developed a plan to upgrade the design of the company's line of routers and switches that will improve performance and throughput. The design team is ready to proceed with the implementation of the plan and is requesting $5 000 000 from the company's capital budget. Economic analysis on the team's project proposal has determined a rate of return on investment of 9.4%. ONS would raise the required funding by using a debt ratio of 30%. The vice president of finance says that experience has shown that this is the optimal capital structure for ONS. The VP's plan for raising the required funding is as follows: 1. $300 000 would be borrowed from the company's bank at an annual rate of 4%. 2. The remainder of the debt would be raised by selling bonds which would pay bondholders 7% per year. 3. The equity portion of the financing would be raised by selling shares to new investors. Shares are currently trading at $50.00 which should return 12% per year to shareholders. (a) How many shares should ORANO Networking Solutions sell and what is the total value of the bonds that should be issued? [4] (b) Should ONS go ahead with this project? Justify your recommendation. [5] (c) What does it mean for a 30% debt ratio to represent the optimal capital structure? Be sure to discuss how the cost of capital would vary, and why, if ONS did not use the proposed 30% debt ratio to potentially finance this project. Be sure to use an appropriate graph of the cost of capital to help explain your answer. [7] Question 2 (a) 70 000 shares; $1 200 000 bonds. (b) Reject the capital budget request as the project return is less than cost of capital (9.4% vs. 10.3%)