Question 6

Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter (OTC) market. During 2012, the Dallas-based company experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa Jen, the companys treasurer, wants to make sure that available funds are being used to their fullest. Management policy is to maintain the current capital structure proportions of 30% Long-term debt, 10% pre ferred stock) and 60% common stock equity for at least the next 3 years. The firm is in the 40% tax bracket.

Stars division and product managers have presented several competing investment opportunities to Jen. However because funds are limited, choices of which projects to accept must be made. The investment opportunities schedule (IOS)

To estimate the firms weighted average cost of capital (WACC), Jen contacted a leading investment banking firm, which provided the financing cost data shown in the following.

Long-term debt: The firm can raise $450,000 of additional debt by selling 15-year, $1,000-par-value, 9% coupon interest rate bonds that pay annual interest. It expects to net $960 per bond after flotation costs. Any debt in excess of $450,000 will have a before-tax cost, rd, of 13%.

Preferred stock, regardless of the amount sold, can be issued with a $70 par value and a 14% annual dividend rate and will net $65 per share after flotation costs.

Common stock equity: The firm expects dividends and earnings per share to be $0.96 and $3.20, respectively, in 2013 and to continue to grow at a constant rate of 11 % per year. The firms stock currently sells for $12 per share. Star expects to have $1,500,000 of retained earnings available in the coming year. Once the retained earnings have been exhausted, the firm can raise additional funds by selling new common stock, netting $9 per share after underpricing and flotation costs.

a. Calculate the cost of each source of financing, as specified:

(1) Long-term debt, first $450,000.

1. The before tax cost of debit is ---

2. The after tax cost of debit will be---

(2) Long-term debt, greater than $450,000.

The after tax cost of debit---

(3) Preferred stock, all amounts.

The cost of preferred stock will be --

(4) Common stock equity, first $1,500,000.

The cost of common stock equity will be ----

(5) Common stock equity, greater than $1,500,000.

The cost of common stock equity will be ---

b. calculate Stars weight average cost of capital (WACC) for each of the following situation;

(1) long-time debt less than 450,001 and common stock equity less than $1,500,001

the WACC will be

long time debt greater than 450,000 and common stock equity less than 1500,001

the Wacc will be

long time debt greater than 450,000 and common stock equity less than 1500,000

the Wacc will be

The breakeven is

The maximum amount offinancing is