O'Grady Company A list of investment opportunities is shown in shown in table 2. It analyze the effect of the increased financing requirements on the weighted average cost of capital (WACC), Jennings contacted a leading investment banking firm that provided the financing cost data given in Table 3. O'Grady is in the 40% tax bracket. Table 1 selected income statement items 2010 2011 2012 2013-Projected net sales 13,860,000 15,940,000 18,330,ooo 21,080,000 Net profit after tax sales 1,520,000 1,750,000 2,020,000 2,323,000 earnings per share 2.88 3.28 3.84 4.40 dividends per share 1.15 1.31 1.54 1.76 Table 2 Investment Opportunities Investment Opportunity IRR Initial Investment A 21% $400,000 B 19 200,000 C 24 700,000 D 27 500,000 E 18 300,000 F 22 600,000 G 17 500,000 Table 3 Financing Cost Data Long term debt: The firm can raise $700,000 of additional debt by selling 10 year, $1,000, 12% annual interest rate bonds to net $970 after flotation costs. Any debt in excess of $700,000 will have a before tax cost, rd, of 18%. Preferred stock: Preferred stock, regardless of the amount sold, can be issued with a $60 par value and a 17% annual dividend rate. it will net $57 per share after flotation costs. Common Stock equity: The firm expects its dividends and earnings to continue to grow at a constant rate of per year. The firm's stock is currently sellling for $20 per share. The firm expects to have $1,300,000 of available retained earnings. Once the retained earnings have been exhausted, the firm can raise additional funds by selling new common stock, netting $16 per share after underpricing and flotation costs. a. Over the relevant range noted in the following table, calculate the after tax cost of each source of financing meeded to complet the table. Source of capital Range of new financing After tax cost (%) long term debt $0-700,000 ______________ $700,000 and above _____________ Preferred Stock $0 and above ______________ Common Stock Equity $0-$1,300,000 __________ $1,300,000 and above __________ b. (1) Determine the break point associated with common equity. A break point represents the total amount of financing that the firm can raise before ti triggers an increase in the cost of a particular financing source. For example, OGrady plans to u se 25% long term debt in its capital structure. That means that for every $1 in debt that the firm uses, it will use $3 from other financing sources (total financing is then $4, and because $1 comes from long term debt, it's share in the total is the desired 25%). From Table 3, we see that after the firm raises $700,000 in long term debt, the cost of this financing source begins to rise. Therefore, the firm can raise total capital of $2.8 million before the cost of debt will rise ($700,000 in debt plus $2.1 million in other sources to maintain the 25% proportion for debt). Therefore, $2.8 millilon is the break point for debt. If the firms wants to maintain a capital structure with 25 % long term debt and it also wants to raise more than $2.8 million in total financing, then it will require more than $700,000 in long term debt, and it will trigger the higher cost of the additional debt it issues beyond $700,000. (2) Using the break points developed in part (1), determine each of the ranges of total new financing over which the firm's weighted average cost of capital (WACC) remains constant. (3) Calculated the weighted average cost of capital for each range of total new financing. Draw a graph with the WACC on the vertical axis and total money raised on the horizontal axis, and show how the firm's WACC increases in "steps" as the amount of money raised increases. c. (1) Sort the investment opportunities described in Table 2 from highest to lowest return, and plot a line on the graph you drew in part (3) above showing how much money is required to fund the investments, starting with the highest return and going to the lowest. In other words, this line will plot the relationship between the IRR on the firm's investments and the total financing required to undertake those investments. (2) Which, if any, of the available investments would you recommend that the firm accept? explan your answer. d (1) Assuming that the specific financing costs do not change, what effect would a shift to a more highly leveraged capital structure consisting of 50% ong term debt, 10% preferred stock, and 40% common stock have on yuor previous findings? (Note: Reowrk parts b and c using these capital structure weights). (2) Which capital structure the original one or t his one seems better? Why? e (1) What type of dividend policy does the firm appear to emply? Does it seem appropriate given the firm's recent growth in sales and profits and given its current investment opportunities? (2) Would you recommend an alternative dividend policy? Explain. How would this policy affect the investments recommended in part c(2)