ACE MANUFACTURING COMPANY

Cost of Capital

The following information pertains to Anderson, Colson, and Emerson (ACE) Manufacturing Company.

1.ACE has a target capital structure of:

Common Equity

45%

Long Term Debt

55%

2.ACE has a corporate tax rate of 40%

3.The company expects to earn net income available to common stockholders of $22,500,000 during the coming year.Their dividend payout ratio is 40%

4.The firm expects to pay a dividend of $4.00 during the next year, and has a constant future growth rate of 7%.ACE's common stock currently sells in the market for $50.00 per share.

5.The flotation cost to issue new common stock would be 10% of selling price.

6.ACE has debt currently outstanding.The outstanding issue has 15 years remaining until maturity and pays an 8% annual coupon (par value = $1,000).The bonds currently sell for $848.00. There will be no flotation charge on the issue of new debt.

Questions (Equally Weighted)

A.What is the yield to maturity on ACE's outstanding debt?

B.What coupon rate will ACE need to offer on newly issued debt (i.e. what is ACE's before-tax cost of new debt)?

C.When the company's tax rate is taken into consideration, what is their after-tax cost of new debt?

D.What is the rate of return (cost of retained earnings) on ACE's common stock using the Dividend Discount Model?

E.What is the firm's WACC using retained earnings as the equity component?

F.Incorporating flotation cost in the Dividend Discount Model, what is the firm's cost of newly issued common stock?

G.What is the firm's WACC using newly issued common stock as the equity component?

H.At what level of total capital raised will the company have to issue new common stock (i.e. what is the break point for retained earnings)?