Atlantic industries has $20,000,000 in bonds outstanding with a coupon rate of 7% paid semi-annually and a maturity of 10 years. The bonds are currently selling at a quoted price of 92 . The company also has 35,000 shares of 10% preferred stock outstanding ( $100 par), currently selling for $96 per share. In addition, the company has 1,000,000 common shares outstanding, selling for $45 per share. The firm has a tax rate of 40%, a beta of 2 , an ROE of 15%, and a dividend payout ratio of 40%. The risk-free rate is 2%, and the return on the market portfolio is 10%. b) Over the last two years, Atlantic industries incurred a cost of $50,000 for conducting a feasibility study on a new project. The project requires purchasing a new machine that will cost $1,500,000 plus an additional $300,000 in installation costs. Management estimates that the firm will obtain annual operating revenues before taxes of $1,250,000 and incur annual operating expenses before taxes of $250,000 over the economic life of the project. The specifications of this machine indicate an economic life of five years and management estimates that at the end of the economic life, the machine will have a salvage value of $350,000. This machine is in asset class 8 , which has a CCA rate of 20%. The asset class is expected to remain open at the end of the project. Finally, management expects to make an initial investment in working capital of $500,000, which will be recovered at the end of the economic life of the project. The initial investment in working capital is part of the capital that needs to be raised. Flotation cost to issue new debt is 4%, new preferred share is 5%, and new common share is 7%. This project will have the same level of risk as the firm. c) Now, assume that the firm has only $200,000 in internally generated funds available. Based on NPV analysis, should the project be undertaken? (17 marks). Problem 1 ( 75 marks): Atlantic industries has $20,000,000 in bonds outstanding with a coupon rate of 7% paid semiannually and a maturity of 10 years. The bonds are currently selling at a quoted price of 92 . The company also has 35,000 shares of 10% preferred stock outstanding ( $100 par), currently selling for $96 per share. In addition, the company has 1,000,000 common shares outstanding, selling for $45 per share. The firm has a tax rate of 40%, a beta of 2 , an ROE of 15%, and a dividend payout ratio of 40%. The risk-free rate is 2%, and the return on the market portfolio is 10%. a) Calculate the capital structure market value weights, cost of debt, cost of preferred equity, cost of common equity, and WACC. (20 marks)
