Question 1 (7 Marks) UNIT 1: COST OF CAPITAL a) Sharp's current capital structure of 60% equity, 35% debt, and 5% preferred stock is c onsidered optimal. This year Sharp expects to have earnings after tax of $3.6 million and to pay out $600,000 in dividends. Sharp can also raise up to $2 million in longterm debt at a pretax interest rate of 10.6% (all debt over $2 million will cost 11.4% pretax), and sell preferred stock at a cost of 11.5%. Sharp's marginal tax rate is 40%. The current value of Sharp's common stock is $36 and a dividend of $2.15 is expected to be paid during the coming year. Dividends have been growing at an annual compound rate of 8% a year and are expected to continue growing at that rate. New shares can be sold to net the firm $34.50. Sharp has an opportunity to invest in the following capital projects. Which one(s) should be accepted? b) Sadaplast has a target capital structure of 65% common equity, 30% debt, and 5%pr eferred stock. The cost of retained earnings is 14%, and the cost of new equity is 15.5%. Sadaplast expects to have a net income of $85 million in the coming year. If the firm sells bonds, up to $25 million can be sold at par value to yield an after-tax cost of 5.4%. An additional $20 million of debentures could be sold to yield an aftertax cost of 7.0%. The after-tax cost of preferred stock financing is estimated to be 11%. Sadaplast has a dividend payout ratio of 25%. What is Sadaplast's weighted Average cost of capital between the first and second break points? (2 marks) c) suppose Zenos Manufacturing is contemplating investing in a new business. An existing company in the target industry has an equity beta of 0.90 but is very conservatively financed with a market value, equity-to-value ratio 95%. Zenos intends to use an equity-tovalue ratio of 30%. What beta should Zeno use in estimating a cost of capital in the new business. (2 marks) d) State a reason that the cost of external equity is greater than the cost of internal equity? marks) Question 1 (7 Marks) UNIT 1: COST OF CAPITAL a) Sharp's current capital structure of 60% equity, 35% debt, and 5% preferred stock is c onsidered optimal. This year Sharp expects to have earnings after tax of $3.6 million and to pay out $600,000 in dividends. Sharp can also raise up to $2 million in longterm debt at a pretax interest rate of 10.6% (all debt over $2 million will cost 11.4% pretax), and sell preferred stock at a cost of 11.5%. Sharp's marginal tax rate is 40%. The current value of Sharp's common stock is $36 and a dividend of $2.15 is expected to be paid during the coming year. Dividends have been growing at an annual compound rate of 8% a year and are expected to continue growing at that rate. New shares can be sold to net the firm $34.50. Sharp has an opportunity to invest in the following capital projects. Which one(s) should be accepted? b) Sadaplast has a target capital structure of 65% common equity, 30% debt, and 5%pr eferred stock. The cost of retained earnings is 14%, and the cost of new equity is 15.5%. Sadaplast expects to have a net income of $85 million in the coming year. If the firm sells bonds, up to $25 million can be sold at par value to yield an after-tax cost of 5.4%. An additional $20 million of debentures could be sold to yield an aftertax cost of 7.0%. The after-tax cost of preferred stock financing is estimated to be 11%. Sadaplast has a dividend payout ratio of 25%. What is Sadaplast's weighted Average cost of capital between the first and second break points? (2 marks) c) suppose Zenos Manufacturing is contemplating investing in a new business. An existing company in the target industry has an equity beta of 0.90 but is very conservatively financed with a market value, equity-to-value ratio 95%. Zenos intends to use an equity-tovalue ratio of 30%. What beta should Zeno use in estimating a cost of capital in the new business. (2 marks) d) State a reason that the cost of external equity is greater than the cost of internal equity? marks)