Mannheims common stock is currently selling for $45 per share. Its last dividend payment was $3.25, and dividend is expected to grow at a constant rate of 3% in the foreseeable future. Mannheims beta is 1.2, the risk free rate is 6%, and the market risk premium is estimated to be 4%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4% with the yield on the Treasury bond of 6.5%.

Sharron, a finance manager of Mannheim, has $400 million capital available consisting of $160 million debt, $140 preferred stock, and $100 million common stock.

Albert asked Stevenson to prepare a report answering the following questions:

1. What are the sources of capital to be included when estimating the Mannheims WACC? In calculating the WACC, if he had to use book values for either debt or equity, which would he choose? Why?
2. What is the cost of debt after tax?
3. What is the firms cost of preferred stock?
4. Explain why there is a cost of retained earnings?
5. What is Mannheims estimated cost of common equity using the CAPM approach
6. What is the estimated cost of common equity using the DCF approach?
7. What is the bond-yield-plus-risk-premium estimate for Mannheims cost of common equity?
8. What is your final estimate for r_s or the average required rate of return?
9. Explain in words why new common stock has a higher cost than retained earnings
10. Mannheim estimates that if it issues new common stock, the flotation cost will be 20%. Mannheim incorporates the flotation costs into the DCF approach. What is the estimated cost of newly issued common stock, considering the flotation cost?
11. What is Mannheims overall, or weighted average, cost of capital (WACC)? Ignore flotation costs.
12. What are the factors affecting Mannheims composite WACC?
13. Calculate the Net Present Value (NPV), Discounted Payback Period (DPP) and Modified Internal Rate of Return (MIRR) for Project A, B, and C.
14. Mannheim Biotechnology Limited has $400 million capital available. Since the projects above are independent, which project should the company invest?
15. If Mannheim had 14% cost of equity, 6% preferred shares and 8% debt, Stevenson proposed a target capital structure of 60% equity, 5% preferred shares, and 35% debt. Explain why he doesnt use more preferred shares since it costs less than debt.