Making Star Products' Financing/Investment Decision

Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter (OTC) market. During 2012, the Dallas-based company experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa Jen, the company's treasurer, wants to make sure that available funds are being used to their fullest. Management policy is to maintain the current capital structure proportions of 30% long-term debt, 10% preferred stock, and 60% common stock equity for at least the next 3 years. The firm is in the 40% tax bracket.

Star's division and product managers have presented several competing investment opportunities to Jen. However, because funds are limited, choices of which projects to accept must be made.Star's current investment opportunities are shown in the table below.

Investment opportunity: A

Internal rate of return (IRR): 15%

Initial investment: $400,000

Investment opportunity: B

Internal rate of return (IRR): 22

Initial investment: 200,000

Investment opportunity: C

Internal rate of return (IRR): 25

Initial investment: 700,000

a. Calculate the cost of each source of financing, as specified:

(1) Long-term debt, first $450,000.