EduSofts market value capital structure is as follows (in millions of dollars): Debt.....$ 50 Equity.........50 $100 If

Question:

EduSoft’s market value capital structure is as follows (in millions of dollars):

Debt.....$ 50

Equity.........50

$100

If the company raises $20 million in additional capital by selling

(1) Convertibles or

(2) Bonds with warrants, what would its WACC be, and how would those figures compare with its current WACC? EduSoft’s tax rate is 40%.

Paul Duncan, financial manager of EduSoft Inc., is facing a dilemma. The firm was founded 5 years ago to provide educational software for the rapidly expanding primary and secondary school markets. Although EduSoft has done well, the firm’s founder believes an industry shakeout is imminent. To survive, EduSoft must grab market share now, and this will require a large infusion of new capital.

Because he expects earnings to continue rising sharply and looks for the stock price to follow suit, Mr. Duncan does not think it would be wise to issue new common stock at this time. On the other hand, interest rates are currently high by historical standards, and with the firm’s B rating, the interest payments on a new debt issue would be prohibitive. Thus, he has narrowed his choice of financing alternatives to two securities: (1) bonds with warrants or (2) convertible bonds. As Duncan’s assistant, you have been asked to help in the decision process by answering the following questions:

Common Stock
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on... Capital Structure
Capital structure refers to a company’s outstanding debt and equity. The capital structure is the particular combination of debt and equity used by a finance its overall operations and growth. Capital structure maximizes the market value of a...