$151$ of $388$

$($LO$11-5)$

Medical Research Corporation is expanding its research and production capacity to introduce a new line of products. Current plans call for the expenditure of $$100$ million on four projects of equal size $($ $$25$ million each$),$ but different returns. Project $A$ is in blood clotting proteins and has an expected return of $18$ percent. Project $B$ relates to a hepatitis vaccine and carries a potential return of $14$ percent. Project $C,$ dealing with a cardiovascular compound, is expected to earn $11\mathrm{.}8$ percent, and Project D$,$ an investment in orthopedic implants, is expected to show a $10\mathrm{.}9$ percent return.

The firm has $$15$ million in retained earnings. After a capital structure with $$15$ million in retained earnings is reached $($in which retained earnings represent $60$ percent of the financing$),$ all additional equity financing must come in the form of new common stock.

Common stock is selling for $$25$ per share and underwriting costs are estimated at $$3$ if new shares are issued. Dividends for the next year will be $$0\mathrm{.}90$ per share $(D_l),$ and earnings and dividends have grown consistently at $11$ percent per year.

The yield on comparative bonds has been hovering at $11$ percent. The investment banker feels that the first $$20$ million of bonds could be sold to yield $11$ percent while additional debt might require a $2$ percent premium and be sold to yield $13$ percent. The corporate tax rate is $2$ percent. Debt represents $40$ percent of the capital structure.

a$.$ Based on the two sources of financing, what is the initial weighted average cost of capital? $($Use $K_d$ and $K_e)$

b$.$ At what size capital structure will the firm run out of retained earnings?

c$.$ What will the marginal cost of capital be immediately after that point?

d$.$ At what size capital structure will there be a change in the cost of debt?

e$.$ What will the marginal cost of capital be immediately after that point?

$f.$ Based on the information about potential returns on investments in the first paragraph and information on marginal cost of capital $($in parts $a,c,$ and $e),$ how large a capital investment budget should the firm use?

g$.$ Graph the answer determined in part $f.$