PROMPT

Private Corp. is a privately held firm that builds and sells widgets globally. The business has prospered in the last few years, but the owners are afraid the growth may be slowing down. To that end, the Finance division started looking at competitors and came up with the following table:

• ABC Corp: EPS = $1.30 | Dividends/Share = $0.16 | Stock Price = $25.34 | ROE = 8.50% | R = 8.00% | Debt Rating = AA | Yield = 3.15%
• XYZ Inc.: EPS = $1.95 | Dividends/Share = $0.23 | Stock Price = $29.85 | ROE = 10.50% | R = 13.00% | Debt Rating = A | Yield = 3.56%
• Widgets Inc: EPS = - $0.37 | Dividends/Share = $0.14 | Stock Price = $22.13 | ROE = 9.78% | R = 12.00% | Debt Rating = BBB+ | Yield = 4.04%
• JKL Corp: EPS = $0.50 | Dividends/Share = $0.05 | Stock Price = $28.56 | ROE = 9.00% | R = 11.50% | Debt Rating = BB+ | Yield = 6.12%
• RTS Sys.: EPS = $1.00 | Dividends/Share = $0.17 | Stock Price = $25.12 | ROE = 11.00% | R = 14.00% | Debt Rating = BB | Yield = 8.02%
• OAZ Tech: EPS = $1.10 | Dividends/Share = $0.18 | Stock Price = $23.54 | ROE = 9.20% | R = 10.50% | Debt Rating = BB | Yield = 7.14%
• Industry Average: EPS = $0.91 | Dividends/Share = $0.16 | Stock Price = $25.76 | ROE =9.66% | R = 11.50% | Debt Rating = - | Yield = 5.34%

While gathering the data above, the Finance division noted that Widgets Inc. took an accounting write-off last year that caused the negative earnings. According to the same note, the impact of that write-off was $1.20 per share.

In the past year, Private Corp. had Earnings per Share of $3.25 and paid a total dividend of $40,000. The company is supported only by equity with no debt. There are a total of 50,000 shares outstanding. Last year the Return on Equity was 18% and the owners believe the required rate for the whole company is 15%. Private Corp's debt rating is regarded by investors as BB.

It may be useful to use the identity:

• g = ROE x b

which states that the growth rate in dividends depends on the ROE and the retention rate.

QUESTION

After looking at all the numbers, the owners of Private Corp. decided that they should pursue a more aggressive growth plan. To that end, they decided to issue debt to fund new projects. After discussing with their banker, the Finance division concluded that they should be able to issue a debt offering at a cost of 2% of the notional value. Management is comfortable issuing $1.25MM in new debt maturing in 5 years, but the Finance division imposed a 5% coupon a year. Management believes they will be able to raise $1.25MM in capital minus the initial cost of issuance. Are they correct? If so, explain why, if not compute how far off they are from the target $1.25MM.