Problem 12-04

The management of a conservative firm has adopted a policy of never letting debt exceed 40 percent of total financing. The firm will earn $16,000,000 but distribute 30 percent in dividends, so the firm will have $11,200,000 to add to retained earnings. Currently the price of the stock is $50; the company pays a $2 per share dividend, which is expected to grow annually at 9 percent. If the company sells new shares, the net to the company will be $48. Given this information, what is the (a,b)

The rate of interest on the firms long-term debt is 11 percent and the firm is in the 32 percent income tax bracket. If the firm issues more than $2,500,000, the interest rate will rise to 12 percent. Given this information, what is the (c,d)

1. cost of retained earnings? Round your answer to one decimal place.

   %

2. cost of new common stock? Round your answer to one decimal place.

   %

3. cost of debt? Round your answer to one decimal place.

   %

4. cost of debt in excess of $2,500,000? Round your answer to one decimal place.

   %

The firm raises funds in increments of $3,800,000 consisting of $1,520,000 in debt and $2,280,000 in equity. This strategy maintains the capital structure of 40 percent debt and 60 percent equity. Develop the marginal cost of capital schedule through $15,000,000. Round your answers for the break-points to the nearest dollar and for the marginal costs to one decimal place.

The marginal cost of capital schedule:

$0 - $
	cost of debt: %
	cost of equity: %
	cost of capital: %

$ - $
	cost of debt: %
	cost of equity: %
	cost of capital: %

above $
	cost of debt: %
	cost of equity: %
	cost of capital: %

What impact would each of the following have on the marginal cost of capital schedule?

1. the firm retains all of its earnings and the price of the stock is unaffected. Round your answers for the break-point to the nearest dollar and for the marginal costs to one decimal place.

   The marginal cost of capital schedule:

   $0 - $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %

   $ - $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %

   above $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %