Question 3:

M.S Ally Pharmacy Company (MSAP) has a target capital structure that consists of 30% debt, 50% common equity and 20% preferred stock. MSAP tax rate is 30%. The company has projects in which it would like to invest with costs that total $1,500,000. MSAP expect to retain $500,000 of net income this year.

The last dividend was $0.50 per share, the current stock price is $7.50 and the growth rate of earnings and dividends is estimated to be 10%. If MSAP raises capital through a new equity issuance, the flotation costs are 10%.

MSAP can issue a 10-year bond at par value carrying an annual coupon rate of 7%. Its $100 par value, 9% preferred stock, can be sold for $98 per share. (Assume debt and preferred stock has no flotation costs.)

Required:

1. The after-tax cost of debt is?
2. The cost of preferred stock is?
3. The cost of common stock is?
4. The weighted average cost of capital is?
5. MSAP has now exhausted its retained earnings. It has just issued new common stocks to raise additional capital. The cost of new common stock is?
6. Following (e) above the weighted average cost of capital (WACC) of MSAP now is ?
7. The equity portion of new investment projects is?
8. At what level of total investment (financing) will cost of equity increase that will lead to an increase in WACC (i.e. from current WACC to new WACC)?
9. Based on the information provided in the questions above, which WACC should be used as the WACC estimates for the next planning period, the one obtained in (d) or (f) above?