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NHD Company is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The company is in a 40% tax
NHD Company is interested in measuring its overall cost of capital. Current investigation has gathered the following data. The company is in a 40% tax bracket. Debt: The firm can raise debt by selling $1,000 par-value, 8% coupon interest rate, 20-year bonds on which annual interest payments will be made. To sell this issue, an average discount of $30 per bond would have to be given to investors. The company also must pay flotation costs of $30 per bond. Preferred Stock: The company can sell 8% preferred stock at its $95 per-share value. The cost of issuing and selling the preferred stock is expected to be $5.00 per share. Common Stock: The company's common stock is currently selling for $90 per share. The firm expects to pay cash dividends of $7.00 per share next year. The firm's dividends have been growing at an annual rate of 6%, and this growth is expected to continue into the future. The stock must be underpriced by $7.00 per share, and flotation costs are expected to amount to $5.00 per share. Retained earnings: when measuring this cost, the firm does not concern itself with the tax bracket or brokerage fees of owners. It expects to have available $100,000 of retained earnings in the coming year; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing. Q1- Calculate the specific cost of each source of financing. Q2- The firm's capital structure weights used in calculating its weighted average cost of capital are shown in the table below. Source of capital Weight Long term debt 20% Preferred stock 30% Common stock equity 50% Total 100% A- Calculate the single break point associated with the firm's financial situation.( Hint: this point results from exhaustion of the firm's retained earnings) B- Calculate the weighted average cost of capital associated with total new financing below the break point calculated in part (1) C- Calculate the weighted average cost of capital associated with total new financing above the break point calculated in part (1) Q3- Using the results of part (d) along with the information shown in the following table on the available investment opportunities, draw the firm's weighted marginal cost of capital (WMCC) schedule and investment opportunities schedule (IOS) on the same set of axes ( Total new financing or investment on the x axis and weighted average cost of capital and IRR on the y axis). Internal Iinvestment rate of return Initial Opportunity (IRR) investment B 11 % $ 200,000 C 9.5% $ 300,000 A 12.9 $ 250,000 F 16.5 $ 400,000 E 11.8 $ 550,000 D 10.1 $ 600,000 G 10.5 $ 300,000 Q4- Which, if any, of the available investments do you recommend that the firm accept? Explain your answer. How much total new financing is required
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