d. Profitability Index 3. Compute the weighted average cost of capital for RIC I
ID: 2806195 • Letter: D
Question
d. Profitability Index 3. Compute the weighted average cost of capital for RIC Inc. using the following information RIC Inc. has decided to finance this product line expansion by raising new capital. The company's optimal capital structure calls for 35% debt, 40% equity, and 25% preferred stock. RIC Inc. can issue a series of 8% coupon bonds with a $1000 par value. The bonds will mature in 10 years and will sell for $946 minus an issuance cost of $5. RIC Inc.'s marginal tax rate is 35%. RIC Inc.'s common stock is currently selling for $22 per share. Its present dividend is $1.96 a share cost of external equity for RIC Inc. assuming an issuance cost of $2.00 per share? and the expected long-term dividend growth rate is 8.5%, what is the res of preferred stock that pay an annual dividend of $2.15. RIC Inc. has just issued sha The preferred stock was sold to the public at a price of $52.00 per share with issuance cost of $2.00 per share. What is the marginal cost of preferred stock for RIC Inc.? a) Using the WACC, recalculate the NPV. Should RIC Inc. undertake the investment? b) When should a company undertake an investment using the NPV? c) Compare the IRR computed (2c) with the WACC. Should RIC Inc. go ahead with the project? (A simple "Yes" or "No" will not do.) d) When should a company undertake an investment using the IRR?Explanation / Answer
(1) Cost of External Equity:
Net Funds received by Company at T0 = $20.00 ($22-$2)
Divident at T1 = 1.96 *(1+0.85)= 2.12
Cost of Equity = Divident (T1)/Outflow at T0 = 2.12/20 = 10.06%
(2) Cost of Preference Shares
Net Funds received by Company at T0 = $50.00 ($52-$2)
Divident at T1 = 2.15
Cost of Equity = Divident (T1)/Outflow at T0 = 2.15/50 = 4.30%
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