risk premium is 7%. Assume the firm's tax rate is 40%. Based on this information, what is the WACC at the optimal capital structure? (10 marks) (Total: 25 marks) QUESTION 5 The Drew Furniture Company is considering the introduction of a new product line. Plant and inventory expansion equal to 50 percent of present asset levels will be necessary to handle the anticipated volume of the new product line. New capital will have to be obtained to finance the asset expansion. Two proposals have been developed to provide the added capital. 1. Raise the K100,000 by issuing 10-year 12 percent bonds. This will change the capital structure from one with about 20 percent debt to one with almost 50 percent debt. The investment banking house estimates the price/earnings ratio, now 12 to 1, will be reduced to 10 to 1 if this method of financing is chosen. 2. Raise the K100,000 by issuing new common stock. The investment banker believes that the stock can be issued to yield K33.33. The price/earnings ratio would remain at 12 to 1 if the stock were issued. The present market price is K36. The company's most recent financial statements are as follows: Drew Furniture Company Balance Sheet As of December 31, 2017 ASSETS Current K 65,000 Plant and equipment 135,000 EQUITIES Debt 5% K 40,000 Common stock 100,000 Retained earnings 60,000 K200,000 K200,000 Income Statement For the Year Ended December 31, 2017 Sales Operating costs Operating income Interest charges Net income before taxes Income taxes Net income K600,000 538.000 K 62,000 2.000 K 60,000 30,000 K 30,000 (a) The vice-president of finance asks you to calculate the earnings per share and the market value of the stock (assuming the pricelearnings ratios given are valid estimates) for the two proposals assuming total sales (including the new product line) of K800,000. Costs exclusive of interest and taxes are about 90 percent of sales. (10 marks) (6) Which proposal would you recommend? Why? (5 marks) (c) Would your answer change if a sales level of K1,200,000 or more could be achieved? Show calculations. (10 marks) (Total: 25 marks)