Question
Lonestar Inc. is planning to expand operations into the Central United States and needs to raise funds for the expansion. The firms investors require a
Lonestar Inc. is planning to expand operations into the Central United States and needs to raise funds for the expansion. The firms investors require a 14 percent rate of return, the firms bonds have a yield to maturity of 7 percent, and the firms marginal tax rate is 21 percent. The firms balance sheet at the end of 2019 appears below. It is important to note that the firms bonds were selling at par value and its stock was selling for a price of 2.25 times its book value at the end of 2019.
Balance Sheet:
A. Complete the following table to determine Lonestars capital structure and the weighted average cost of capital (WACC).
Table 3: WACC for Initial Conditions
B. Assume Lonestars stock price increases to 3.25 times its book value and the cost of equity increases to 15 percent. Complete the following table to determine the firms new WACC? Assume the marginal tax rate and cost of debt remain the same.
Table 4: WACC for New Conditions
Assets Debt & Equity Cash $ 2,010,000 4,580,000 Accounts Receivable Inventories 1,540,000 8,130,000 Long-term debt Total current assets $ 8,141,000 Net property, plant, & equipment 32,575,000 Common equity 32,564,000 Total assets Total debt & 40,705,000 equity 40,705,000 Component Market Value Balance Sheet Proportion After-tax Cost Product Long-term debt Common equity Totals WACC = Component Market Value Balance Sheet Proportion After-tax Cost Product Long-term debt Common equity Totals WACC =Step by Step Solution
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