In October 2016, Stevens Corporation executives were working on their capital budget for 2017. Stevens expects to have the following book value capital structure on December 31, 2016:

Debt $12,000,000

Preferred stock (25,000 shares) 2,500,000

Common stock (1,000,000 shares) 5,000,000

Retained earnings 10,000,000

Total capital $29,500,000

Earnings per share have grown steadily over the past 7 years, from $1.65 in 2009 to $3.00 projected for 2016. The investment community expects growth to continue at a slower rate; the average past growth rate of 9% has recently dropped to 5%, and it is expected to remain constant at this level. On the basis of a 5% growth rate, this stock now sells at a price/earnings ratio of 6x (i.e. the price is 6 times -4- the earnings per share). The last dividend ( D0 ) was $1.88; it is expected to increase at the new 5% growth rate.

Stevens preferred stock, which was issued several years ago, has a book value of $100 per share, and it pays a dividend of $9. The yield currently on preferred stock of this degree of risks is 11.25%.

The debt consists of $12,000,000 of $1,000 par, 20-year bonds with a 4.135% coupon, payable semiannually. These bonds were issued 7 years ago, and hence have 13 years remaining to maturity. The yield to maturity for these bonds is currently 6%. The addition to retained earnings projected for 2017 is $1,026,000.

These funds will be available during the 2017 budget year. The corporate tax rate, including state income taxes, is 40%. In addition, new securities can be sold at the following costs:

Debt: Up to $3 million of new bonds can be sold at a cost of 6.67%. Debt in the range of $3 to $5 million would cost 7%, while all debt over $5 million would cost Stevens 9.33%.

Preferred: Additional preferred stock can be sold to investors at a price of $100 per share (which is par value) with a dividend of 11.25%, but the company will incur a 5% floatation cost, and hence net $95.

Common: Up to $3 million of new common stock can be sold at the current market price, with an underwriting cost of 5%. All common stock over $3 million would also have underwriting costs of 5%, but the offering price must be lowered to $16.11.

a. Determine the capital structure of Stevens based on (i) book value and (ii) market value.

b. Determine the costs of (i) the new preferred stock and (ii) the two types of new common stocks.

c. At what dollar amounts of new capital will breaks occur in the MCC schedule?

d. Calculate the WACC in the interval between each of these breaks using the book value capital structure and then plot the MCC schedule.

e. Calculate the WACC in the interval between each of these breaks using the market value capital structure and then plot the MCC schedule.