A company, West Berwick Enterprises, has a capital structure as follows: Total C

Question

A company, West Berwick Enterprises, has a capital structure as follows:                                   

Total Capital               $1,000,000                                                                
Debt                            $400,000

Preferred Stock           $100,000

Common Equity         $500,000   

What would be the minimum expected return from a new capital investment project to satisfy the suppliers of the capital? Assume the applicable tax rate is 40%, interest on debt is 7%, flotation cost per share of preferred stock is $0.75, and flotation cost per share of common stock is $4. The preferred and common stocks are selling in the market for $26 and $143 a share respectively, and they are expected to pay a dividend of $1.50 and $4.50, respectively, in one year. The company's dividends are expected to grow at 7% per year. The firm would like to maintain the existing capital structure to finance the new project.           

Explanation / Answer

Capital Structure Weight Debt $400,000 40.00% Preferred Stock $100,000 10.00% Common Equity $500,000 50.00% Total Assets $1,000,000 Minimum Expected Return Price Div Float Cost Pref Stk $26.00 $1.50 $0.75 Comn Stk $143.00 $4.50 $4.00 Tax Rate 40.00% Debt Int Rate 7.00% Div Growth Rate 7.00% Cost of Debt 4.20% Cost of Pref Stk 5.94% Cost of Comn Stk 10.24% WACC 7.39%

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