PROBLEM FOR CHAPTERS TEN AND ELEVEN Saint Leo Manufacturing is going to introduc

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Question

PROBLEM FOR CHAPTERS TEN AND ELEVEN

Saint Leo Manufacturing is going to introduce a new product line and to accomplish this

it has four projects analyzed in which it wants to invest a total of $100 million. Your job is to

find what it will cost to raise this amount of capital and based on the cost of capital determine which of the

projects should be accepted by the firm to invest in.

PROJECTS

A B C D

INVESTMENT $                 30,000,000 $       20,000,000 $     25,000,000 $   25,000,000

EXPECTED RETURN 10.00% 14.00% 11.50% 16.00%

The firms capital structure consists of:
FMV

CAPITAL PERCENTAGE AMOUNT

DEBT 40% $     20,000,000

PREFERRED STOCK 15% $       7,500,000

COMMON STOCK 45% $     22,500,000

$     50,000,000

Other information about the firm:

CORPORATE TAX RATE 35%

DEBT

CURRENT PRICE $                     1,075.00

ANNUAL INTEREST 6.00% CURRENT INTEREST PAID SEMIANNUALLY

ORIGINAL MATURITY 25 YEARS, BUT NOW 20 YEARS LEFT

MATURITY VALUE $                     1,000.00

FLOTATION COST INSIGNIFICANT

MARKET YIELD PROJECTED:

   UP TO $20 MILLION 9%

   ABOVE $20 MILLION 12% 3 % additional premium

PREFERRED

CURRENT PRICE $                         35.00

LAST DIVIDEND (D0) $                           2.63 FIXED AT 7.5% OF PAR

FLOTATION COST $                           1.00

NEXT DIVIDEND (D1) $                           2.63

COMMON

CURRENT PRICE $                         25.00

LAST DIVIDEND (D0) $                           1.00

RETAINED EARNINGS $                 10,000,000

GROWTH RATE (g) 9%

FLOTATION COST $                           1.50

NEXT DIVIDEND (D1) $                         1.090

NOTE - Once retained earnings is maxed out new common stock will need to be issued.

Any preferred stock would be new preferred stock. You may want to review case in chapter 11.

REQUIRED:

In all of the required parts one part builds on the previous part. If you can't do a part use the

set of other numbers to solve the next part.

a. What is the current Kd, Kp and Ke assuming no new debt or stock?

b. Since any new capital investment will require issuing new perferred stock, what would the

     the new returns be preferred stock (knp) and the new cost of capital?

c. What amount of increase (marginal cost of capital) in capital structure will the firm run

     out of retained earnings and be forced to issue new common stock?

d. If new common stock has to be issued what will the new return required be (Kne) and the

     new cost of capital?

Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.

Part a

Current price $

Maturity value $

Interest payment $

Payment periods

Yield rate %

Annual yield %

Kd %

Kp %

Ke %

Current Cost of capital %

Part b

Use your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%; = % Knp preferred stock %

New cost of capital %

Part c

If the capital structure increases more than $

new common stock will have to be issued to finance new projects since internally generated RE runs out,
and the required return on common stock will increase as demanded by shareholders.

Part d

Kne common stock %

If you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%= % New cost of capital %

PROBLEM FOR CHAPTERS TEN AND ELEVEN

Saint Leo Manufacturing is going to introduce a new product line and to accomplish this

it has four projects analyzed in which it wants to invest a total of $100 million. Your job is to

find what it will cost to raise this amount of capital and based on the cost of capital determine which of the

projects should be accepted by the firm to invest in.

PROJECTS

A B C D

INVESTMENT $                 30,000,000 $       20,000,000 $     25,000,000 $   25,000,000

EXPECTED RETURN 10.00% 14.00% 11.50% 16.00%

The firms capital structure consists of:
FMV

CAPITAL PERCENTAGE AMOUNT

DEBT 40% $     20,000,000

PREFERRED STOCK 15% $       7,500,000

COMMON STOCK 45% $     22,500,000

$     50,000,000

Other information about the firm:

CORPORATE TAX RATE 35%

DEBT

CURRENT PRICE $                     1,075.00

ANNUAL INTEREST 6.00% CURRENT INTEREST PAID SEMIANNUALLY

ORIGINAL MATURITY 25 YEARS, BUT NOW 20 YEARS LEFT

MATURITY VALUE $                     1,000.00

FLOTATION COST INSIGNIFICANT

MARKET YIELD PROJECTED:

   UP TO $20 MILLION 9%

   ABOVE $20 MILLION 12% 3 % additional premium

PREFERRED

CURRENT PRICE $                         35.00

LAST DIVIDEND (D0) $                           2.63 FIXED AT 7.5% OF PAR

FLOTATION COST $                           1.00

NEXT DIVIDEND (D1) $                           2.63

COMMON

CURRENT PRICE $                         25.00

LAST DIVIDEND (D0) $                           1.00

RETAINED EARNINGS $                 10,000,000

GROWTH RATE (g) 9%

FLOTATION COST $                           1.50

NEXT DIVIDEND (D1) $                         1.090

NOTE - Once retained earnings is maxed out new common stock will need to be issued.

Any preferred stock would be new preferred stock. You may want to review case in chapter 11.

REQUIRED:

In all of the required parts one part builds on the previous part. If you can't do a part use the

set of other numbers to solve the next part.

a. What is the current Kd, Kp and Ke assuming no new debt or stock?

b. Since any new capital investment will require issuing new perferred stock, what would the

     the new returns be preferred stock (knp) and the new cost of capital?

c. What amount of increase (marginal cost of capital) in capital structure will the firm run

     out of retained earnings and be forced to issue new common stock?

d. If new common stock has to be issued what will the new return required be (Kne) and the

     new cost of capital?

Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.

Part a

Current price $

Maturity value $

Interest payment $

Payment periods

Yield rate %

Annual yield %

Kd %

Kp %

Ke %

Current Cost of capital %

Part b

Use your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%; = % Knp preferred stock %

New cost of capital %

Part c

If the capital structure increases more than $

new common stock will have to be issued to finance new projects since internally generated RE runs out,
and the required return on common stock will increase as demanded by shareholders.

Part d

Kne common stock %

If you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%= % New cost of capital %

Explanation / Answer

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