The Ewing Distribution Company is planning a $100 million expansion of its chain

Question

The Ewing Distribution Company is planning a $100 million expansion of its chain of discount service stations to several neighboring states. This expansion will be financed, in part with debt issued with a coupon interest rate of 15 percent. The bonds have a 10-year maturity and a $1,000 face value and they will be sold to net Ewing $990 after issue costs. Ewings marginal tax rate is 40 percent. Preferred Stock will cost Ewing 14 percent after taxes. Ewings common stock pays a dividend of $2 per share. The current market price per share is $15 and new shares can be sold to net $14 per share.
Ewings dividends are expected to increase at an annual rate of 5 percent for the foreseeable future. Ewing expects to have $20 million of retained earnings available to finance the expansion. Ewings target capital structure is as follows:
Debt 20%
Preferred stock 5
Common equity 75__

Explanation / Answer

Cost of debt:

$990 = $68( PVIFA kd ,10 ) + $1,000( PVIFkd ,10 )

kd = 6.9%

kd = 6.9% (1 - 0.4) = 4.1%

kp = 7.5%

= $2.00(1.05)/ $35=.11or 11%

Ke=.11or 11%

ka = 0.2(4.1%) + 0.05(7.5%) + 0.75(11%) = 9.4%

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