Alfa Trading Co. operates a very successful chain of dairy shops and tea houses across the South Caucasus. Alfa needs to raise funds for its planned expansion into Ukraine and Moldova. The company’s balance sheet at the end of 2018 is as follows:

At present, the company’s common stock is selling for a price equal to 2 times its book value, and the company’s investors require a 10 percent return. The company’s bonds command a yield to maturity of 6 percent, and the company faces a marginal tax rate of 20 percent. At the end of the previous year, Alfa’s bonds were trading near their par value.

a. What does Alfa’s capital structure look like?

b. What is Alfa’s weighted average cost of capital?

c. If Alfa’s stock price were to rise such that it sold at 3.5 times its book value and the required rate is increased to 15 percent, what would the firm’s weighted average cost of capital be (assuming the cost of debt and tax rate do not change)?

d. Historically, Alfa has owned each of its dairy shops and tea houses. The firm’s new CFO has asked you to consider the potential effect on the firm’s cost of capital if it were to sell the stores to a real estate investor with an agreement to lease them back (that is, rent them). No computations required.

Transcribed Image Text:

Cash $1,500,000 Accounts 2,400,000 receivable Inventories 1,310,000 Long-term $ debt 4,000,000 Net property, 2,500,000 Common 3,710,000 plant, and equity equipment Total assets $7,710,000 Total debt $7,710,000 and equity