M 1 During the last few years, Seaside Laboratories, a large invetsor-owned business, has been too constrained 2 by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, 3 and the company has decided to look seriously at a major expansion program that had been proposed 4 by the marketing department. Your group needs to assist Jessica Jones, the financial vice president. Your first 5 task is to estimate Seaside's cost of capital. Jones has provided data that she believes is relevant to your task. 6 (1) The firm's tax rate is 40 percent. 7 (2) The current price of Seaside's 12 percent coupon, semiannual-payment, noncallable bonds with 15 emaining to maturity is $1,153.72. Seaside does not use short-term interest-bearing debt on a 9 permanent basis. New bonds would be privately placed with no flotation costs. 10 (3) Seaside's common stock is currently selling at $50 per share (PO). Its last dividend (DO) was $3.12, and 11 dividends are expected to grow at a constant rate of 5.8 percent in the foreseeable future. Seaside's beta 12 is 1.2, the yield on T-bonds is 5.6 percent, and the market risk premium is estimated to be 6 percent. For the 13 debt-cost-plus-risk-premium approach, the firm uses a 3.2 percentage point risk premium. 14 (4) Seaside's target capital structure is 40 percent long-term debt and 60 percent common equity. h. Suppose Seaside issues 30-year debt with a par value of $1,000 and a coupon rate of 14 percent, paid annually. If flotation costs are 2 percent, what is the after-tax cost of debt for the new bond? 15 16 17 18 19 To help you structure the task, Jessica Jones has asked you to answer the following questions: . Seaside estimates that if it issues new common stock, the flotation cost will be 15 percent. Seaside incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation costs? Number of periods Gross par value Coupon rate Coupon payment Flotation costs Net par value Before-tax cost of debt Tax rate After-tax cost of debt 20 21 Price PO 22 Last dividend payment DO 23 Expected growth rate 24 Next dividend payment Di 25 Flotation costs 26 Price after flotation costs 27 Estimated cost of new stock $50.00 $3.12 5.8% $3.30 15% $0.14 i. What will be the CCC if Seaside issues the new common stock and the new debt, and keeps the same capital structure? E(Rd) E(Re) 0.00% 0.00% =C40 1-C27 We CCC j. In general, what are the factors that affect a CCC estimate? (Narrative) Sheet1 M 1 During the last few years, Seaside Laboratories, a large invetsor-owned business, has been too constrained 2 by the high cost of capital to make many capital investments. Recently, though, capital costs have been declining, 3 and the company has decided to look seriously at a major expansion program that had been proposed 4 by the marketing department. Your group needs to assist Jessica Jones, the financial vice president. Your first 5 task is to estimate Seaside's cost of capital. Jones has provided data that she believes is relevant to your task. 6 (1) The firm's tax rate is 40 percent. 7 (2) The current price of Seaside's 12 percent coupon, semiannual-payment, noncallable bonds with 15 emaining to maturity is $1,153.72. Seaside does not use short-term interest-bearing debt on a 9 permanent basis. New bonds would be privately placed with no flotation costs. 10 (3) Seaside's common stock is currently selling at $50 per share (PO). Its last dividend (DO) was $3.12, and 11 dividends are expected to grow at a constant rate of 5.8 percent in the foreseeable future. Seaside's beta 12 is 1.2, the yield on T-bonds is 5.6 percent, and the market risk premium is estimated to be 6 percent. For the 13 debt-cost-plus-risk-premium approach, the firm uses a 3.2 percentage point risk premium. 14 (4) Seaside's target capital structure is 40 percent long-term debt and 60 percent common equity. h. Suppose Seaside issues 30-year debt with a par value of $1,000 and a coupon rate of 14 percent, paid annually. If flotation costs are 2 percent, what is the after-tax cost of debt for the new bond? 15 16 17 18 19 To help you structure the task, Jessica Jones has asked you to answer the following questions: . Seaside estimates that if it issues new common stock, the flotation cost will be 15 percent. Seaside incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, taking into account the flotation costs? Number of periods Gross par value Coupon rate Coupon payment Flotation costs Net par value Before-tax cost of debt Tax rate After-tax cost of debt 20 21 Price PO 22 Last dividend payment DO 23 Expected growth rate 24 Next dividend payment Di 25 Flotation costs 26 Price after flotation costs 27 Estimated cost of new stock $50.00 $3.12 5.8% $3.30 15% $0.14 i. What will be the CCC if Seaside issues the new common stock and the new debt, and keeps the same capital structure? E(Rd) E(Re) 0.00% 0.00% =C40 1-C27 We CCC j. In general, what are the factors that affect a CCC estimate? (Narrative) Sheet1