Integrative Case $4$ Enviro Plastics Company

Since its inception, Enviro Plastics Company has been revolutionizing plastic and trying to

do its part to save the environment. Enviro's founder, Marion Cosby, developed a

biodegradable plastic that her company is marketing to manufacturing companies

throughout the southeastern United States. After operating as a private company for six

years, Enviro went public in $2015$ and is listed on the Nasdaq stock exchange.

As the chief financial officer of a young company with lots of investment opportunities,

Enviro's CFO closely monitors the firm's cost of capital. The CFO keeps tabs on each of the

individual costs of Enviro's three main financing sources: long$-$term debt, preferred stock,

and common stock. The target capital structure for Enviro is given by the weights in the

following table:Source of capital

Long$-$term debt

Preferred stock

Common stock equity

Total

At the present time, Enviro can raise debt by selling $20-$year bonds with a $$1,000$ par value

and a $10\mathrm{.}5\%$ annual coupon interest rate. Enviro's corporate tax rate is $21\%,$ and its bonds

generally require an average discount of $$45$ per bond and flotation costs of $$32$ per bond

when being sold. Enviro's outstanding preferred stock pays a $9\%$ dividend and has a $$95-$

per$-$share par value. The cost of issuing and selling additional preferred stock is expected to

be $$7$ per share. Because Enviro is a young firm that requires lots of cash to grow, it does notAlthough Enviro's current target capital structure includes $20\%$ preferred stock, the company

is considering using debt financing to retire the outstanding preferred stock, thus shifting

their target capital structure to $50\%$ long$-$term debt and $50\%$ common stock. If Enviro shifts

its capital mix from preferred stock to debt, its financial advisors expect its beta to increase

to $1\mathrm{.}5.$

To Do

a$.$ Calculate Enviro's current after$-$tax cost of long$-$term debt.

b$.$ Calculate Enviro's current cost of preferred stock.To Do

a$.$ Calculate Enviro's current after$-$tax cost of long$-$term debt.

b$.$ Calculate Enviro's current cost of preferred stock.

c$.$ Calculate Enviro's current cost of common stock.

d$.$ Calculate Enviro's current weighted average cost capital $($WACC$).$

e$.1.$ Assuming that the cost of debt financing does not change, what effect would

a shift to a more highly leveraged capital structure consisting of $50\%$ long$-$

term debt, $0\%$ preferred stock, and $50\%$ common stock have on the risk

premium for Enviro's common stock?

What would be Enviro's new cost of common equity?

What would be Enviro's new weighted average cost of capital $($WACC$)?$

Which capital structure$-$the original one or this one$-$seems better? Why?