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please solve numerically and ans each part briefly with explanation O'Grady Apparel Company was founded nearly 150 years ago when an Irish merchant named Garrett
please solve numerically and ans each part briefly with explanation
O'Grady Apparel Company was founded nearly 150 years ago when an Irish merchant named Garrett O'Grady landed in Halifax with an inventory of heavy canvas, which he hoped to sell for tents and wagon covers. Instead, he turned to the sale of harder wearing clothing. Today, the O'Grady Apparel Company is a small manufacturer of fabrics and clothing whose common shares are traded on the Toronto Stock Exchange, In 2008, the Nova Scotia-based company experienced sharp increases in sales in both domestic and European markets, resulting in record earnings. Sales rose from $15.9 million in 2007 to $18.3 million in 2008 with earnings per share of $3.28 and $3.84, respectively. The European sales represented 29 percent of total sales in 2008 , up from 24 percent the year before and only 3 percent in 1998, 1 year after foreign operations were launched. Although foreign sales represent nearly one-third of total sales, the growth in the domestic market is expected to affect the company most markedly. For 2009, management expects sales to surpass \$21 million, and earnings per share are expected to rise to $4.40. (Selected income statement items are presented in Table 1.) Because of the recent growth, Margaret Jennings, the corporate treasurer, is concerned that available funds are not being used to their fullest. The projected $1,300,000 of internally generated funds for 2009 are expected to be insufficient to meet the company's expansion needs. Management's policy is to maintain the current capital structure proportions of 25 percent long-term debt, 10 percent preferred equity, and 65 percent common equity for at least the next 3 years. In addition, it plans to continue paying out 40 percent of its earnings as dividends. Total capital expenditures are yet to be determined. Ms. Jennings has been presented with several competing investment opportunities by division and product managers. However, because funds are limited, choices of which projects to accept must be made. The investment opportunities schedule (IOS) is shown in Table 2. To analyze the effect of the increased financing requirements on the weighted average cost of capital (WACC), Ms. Jennings contacted a leading investment banking firm that provided the financing cost data given in Table 3. 0 Grady is in the 40 percent tax bracket. TABLE 3 Financing Cost Data Long-term debt: The firm can raise $700,000 of additional debt by selling a 10 -year bond, with a 12 percent coupon rate. The coupons are paid semi-annually. As a result of changing market yields, the bonds can be sold for $995 per $1,000 of par value. Flotation costs of 2.5 percent of par must also be paid, Any debt in excess of $700,000 will have a before-tax cost, rd, of 18%. Preferred equity: Preferred shares, regardless of the amount sold, can be issued with a $60 stated val..e, and a 17% annual dividend rate, and will net $57 per share after flotation costs. Common equity: The firm expects its dividends and earnings to continue to grow at a constant rate of 15% per year. The firm's shares currently trade for $20 per share. The firm can raise additional funds by selling new common shares, netting $16 per share after discounting and flotation costs, REQUIRED a. Calculate the after-tax cost of each source of financing, being sure to include the range of financing the cost applies to. b. (1) Determine the break points associated with each source of capital. (2) Using the break points developed in (1), determine the ranges of new financing for which costs of capital must be calculated. (3) Calculate the weighted average cost of capital for each range of total new financing. c. Using your findings in b, calculate the overall cost of capital for O'Grady Apparel. Which of the available investment projects should the firm select? Explain your answer. d. (1) Assuming that the specific financing costs do not change, what effect would a shift to a more highly levered capital structure consisting of 50 percent long-term debt, 10 percent preferred equity, and 40 percent common equity have on your previous findings? (Note: Rework b and c using these capital structure weights.) (2) Which capital structure - the original one or this one - seems better? Why? If the firm moved from the original capital structure to the new structure, what do you expect would happen to the cost of the three sources of financing? Explain. e. (1) What type of dividend policy does the firm appear to employ? Does it seem appropriate given the firm's recent growth in sales and profits, and its current investment opportunities? (2) Would you recommend an alternative dividend policy? Explain. How would this policy impact the investments recommended in c ? Recalculate the MCC using your new dividend policy. O'Grady Apparel Company was founded nearly 150 years ago when an Irish merchant named Garrett O'Grady landed in Halifax with an inventory of heavy canvas, which he hoped to sell for tents and wagon covers. Instead, he turned to the sale of harder wearing clothing. Today, the O'Grady Apparel Company is a small manufacturer of fabrics and clothing whose common shares are traded on the Toronto Stock Exchange, In 2008, the Nova Scotia-based company experienced sharp increases in sales in both domestic and European markets, resulting in record earnings. Sales rose from $15.9 million in 2007 to $18.3 million in 2008 with earnings per share of $3.28 and $3.84, respectively. The European sales represented 29 percent of total sales in 2008 , up from 24 percent the year before and only 3 percent in 1998, 1 year after foreign operations were launched. Although foreign sales represent nearly one-third of total sales, the growth in the domestic market is expected to affect the company most markedly. For 2009, management expects sales to surpass \$21 million, and earnings per share are expected to rise to $4.40. (Selected income statement items are presented in Table 1.) Because of the recent growth, Margaret Jennings, the corporate treasurer, is concerned that available funds are not being used to their fullest. The projected $1,300,000 of internally generated funds for 2009 are expected to be insufficient to meet the company's expansion needs. Management's policy is to maintain the current capital structure proportions of 25 percent long-term debt, 10 percent preferred equity, and 65 percent common equity for at least the next 3 years. In addition, it plans to continue paying out 40 percent of its earnings as dividends. Total capital expenditures are yet to be determined. Ms. Jennings has been presented with several competing investment opportunities by division and product managers. However, because funds are limited, choices of which projects to accept must be made. The investment opportunities schedule (IOS) is shown in Table 2. To analyze the effect of the increased financing requirements on the weighted average cost of capital (WACC), Ms. Jennings contacted a leading investment banking firm that provided the financing cost data given in Table 3. 0 Grady is in the 40 percent tax bracket. TABLE 3 Financing Cost Data Long-term debt: The firm can raise $700,000 of additional debt by selling a 10 -year bond, with a 12 percent coupon rate. The coupons are paid semi-annually. As a result of changing market yields, the bonds can be sold for $995 per $1,000 of par value. Flotation costs of 2.5 percent of par must also be paid, Any debt in excess of $700,000 will have a before-tax cost, rd, of 18%. Preferred equity: Preferred shares, regardless of the amount sold, can be issued with a $60 stated val..e, and a 17% annual dividend rate, and will net $57 per share after flotation costs. Common equity: The firm expects its dividends and earnings to continue to grow at a constant rate of 15% per year. The firm's shares currently trade for $20 per share. The firm can raise additional funds by selling new common shares, netting $16 per share after discounting and flotation costs, REQUIRED a. Calculate the after-tax cost of each source of financing, being sure to include the range of financing the cost applies to. b. (1) Determine the break points associated with each source of capital. (2) Using the break points developed in (1), determine the ranges of new financing for which costs of capital must be calculated. (3) Calculate the weighted average cost of capital for each range of total new financing. c. Using your findings in b, calculate the overall cost of capital for O'Grady Apparel. Which of the available investment projects should the firm select? Explain your answer. d. (1) Assuming that the specific financing costs do not change, what effect would a shift to a more highly levered capital structure consisting of 50 percent long-term debt, 10 percent preferred equity, and 40 percent common equity have on your previous findings? (Note: Rework b and c using these capital structure weights.) (2) Which capital structure - the original one or this one - seems better? Why? If the firm moved from the original capital structure to the new structure, what do you expect would happen to the cost of the three sources of financing? Explain. e. (1) What type of dividend policy does the firm appear to employ? Does it seem appropriate given the firm's recent growth in sales and profits, and its current investment opportunities? (2) Would you recommend an alternative dividend policy? Explain. How would this policy impact the investments recommended in c ? Recalculate the MCC using your new dividend policy Step by Step Solution
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