Bond Data. Two dollar-denominated bonds are currently outstanding. Bond A has a 7.00 percent coupon, pays interest semi-annually, sells for $900.00, matures in 25 years, and can be called at a price of $1050 in 5 years. Bond B has a 10.00 percent semi-annual coupon, sells for $1125.00 also matures in 25 years, and can be called at a price of $1050 in 5 years. ABCs federal-plus-state tax rate is 35 percent. Assume that the analysis is conducted today. New bonds carrying the prevailing rate could be sold to institutional investors, and no bond flotation cost would be involved.

Preferred Stock Data. ABC has one issued of preferred stock outstanding, a perpetual and non-callable preferred that pays a $7.00 annual dividend, has a $100 par value, and currently sells for $110 per share. Investment bankers have indicated that ABC could sell additional shares with a dividend rate that would provide the same market yield, but such a sale would incur a flotation cost of 5.0%.

Common Equity Cost Data

CAPM ABCs estimated beta coefficient is 1.0. The risk-free rate is 3.0%, and the market risk premium is estimated to be 6.0%.

DCF ABCs stock sells for $21 per share. The company currently pays a dividend D(0) of $1.00, which is expected to grow 5.0% indefinitely.

yield to call = Yield(1-1-2000,31-12-2004,10%,112.5,105,2) = 7.77%

Average cost of debt = (10.4%+7.7%)/2 = 9.05%

After tax cost of debt = Rd*(1-T) = 9.05 * (1-0.35) = 5.88%

Cost of equity = 3% + 1*6% = 9%

DCF cost of equity:

current period dividend *(1+ growth rate) = 1*(1+5%) = 1.05

Price = 21 , Growth = 5%

Cost of equity = 1.05/21+5% = 10%

WACC = 8.75%

7.(a) Assuming that ABC will have $7.5 million of new retained earnings during the coming

year and that all capital is raised in accordance with the target capital structure, how large

could the capital budget be before the firm is required to sell new common stock to finance

the capital budget?

(b) What would the WACC be for a $20 million project? Use the DCF approach for your new cost of equity. Weight your cost of equity between retained earnings and new stock issuance and use that to calculate your new WACC -

Amount of stock issued fee applies to all equity Net Price raised up to this amount Common with $21 (thousands) Flotation Cost base $21.00 0.00% $5,000 $18.90 10.00% $15.75 $10,000 25.00% $20,000 $12.60 40.00% Amount of stock issued fee applies to all equity Net Price raised up to this amount Common with $21 (thousands) Flotation Cost base $21.00 0.00% $5,000 $18.90 10.00% $15.75 $10,000 25.00% $20,000 $12.60 40.00%