Table 9.1 A firm has determined its optimal capital structure, which is composed of the following...
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Table 9.1 A firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions. Source of Capital Long-term debt Preferred stock Target Market Proportions 20% Common stock equity 10 70 Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in flotation costs. The firm's before-tax cost of debt is 8%. Additionally, the firm's tax rate is 40 percent. Also, assume that the firm has two project in hand to decide. Project X has an expected return of 10% and is expected to be financed by debt whereas Project Y has an expected return of 13% and is expected to be financed by issuing new common stock. a) b) c) Calculate the WACC for the firm based on target weights given above. Which project(s) should be accepted and rejected? Why? Assume that firm has made a change in its financing decision for both projects. The firm now decides to finance Project X by new common stock instead of debt and decides to finance Project Y by issuing preferred stock? Would your answer in part b change? Why? Table 9.1 A firm has determined its optimal capital structure, which is composed of the following sources and target market value proportions. Source of Capital Long-term debt Preferred stock Target Market Proportions 20% Common stock equity 10 70 Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in flotation costs. The firm's before-tax cost of debt is 8%. Additionally, the firm's tax rate is 40 percent. Also, assume that the firm has two project in hand to decide. Project X has an expected return of 10% and is expected to be financed by debt whereas Project Y has an expected return of 13% and is expected to be financed by issuing new common stock. a) b) c) Calculate the WACC for the firm based on target weights given above. Which project(s) should be accepted and rejected? Why? Assume that firm has made a change in its financing decision for both projects. The firm now decides to finance Project X by new common stock instead of debt and decides to finance Project Y by issuing preferred stock? Would your answer in part b change? Why?
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