Question
Edna Recording Studios, Inc., reported earnings available for common shareholders of $4,200,000 last year. From that, the company paid a dividend of $1.26 on each
Edna Recording Studios, Inc., reported earnings available for common shareholders of $4,200,000 last year. From that, the company paid a dividend of $1.26 on each of its 1,000,000 common shares outstanding. The capital structure of the company is 40 percent debt, 10 percent preferred equity, and 50 percent common equity. The companys tax rate is 40 percent.
a.If the market price of common shares is $40 and dividends are expected to grow at a rate of 6 percent a year for the foreseeable future, what is the companys cost of reinvested profits (or additions to retained earnings)?
b.If flotation costs on new shares of common stock amount to $3.25 per share, what is the companys cost of financing with new common shares?
c.The company can issue preferred shares with a $25 stated value and a $2 dividend. Flotation cost would amount to $3 per share. What is the cost of preferred equity financing?
d.The company can issue 5-year bonds, with an 8.2 percent coupon rate. The coupons are paid semiannually. As a result of changing market yields, the bonds can be sold for $993.50 per $1000 of par value (or face value). Flotation costs of $30 per bond will have to be paid. Calculate the after-tax cost of debt.
e.What is the maximum investment that Edna Recording can make in new projects before it must issue new common shares? Assume for the upcoming fiscal year, reinvested profits will increase by 7.5 percent from the level recorded the previous year.
f.What is the Weighted Average Cost of Capital (WACC) for projects with a required investment between $1 and the amount calculated in part e?
g.What is the Marginal Cost of Capital (MCC) for projects with a required investment above the amount calculated in part e?
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