Show Solutions and explain how did they solve (Cost of Capital, Financial Leverage and Capital Structure)

Problem 5

Google is evaluating its cost of capital under alternative financing arrangements. In consultation with investment bankers, Google expects to be able to issue new debt at par with a coupon rate of 9.0% and to issue new preferred stock with a P2.90 per share dividend at P24 a share. The common stock of Google is currently selling for P23.00 a share. Google expects to pay a dividend of P1.60 per share next year. Market analysts foresee a growth in dividends in Invest stock at a rate of 5% per year. Google' marginal tax rate is 35%. If Google raises capital using 25% debt, 10% preferred stock, and 65% common stock,

what is Google's cost of capital?

Problem 6

Carolina Fastener, Inc., makes a patented marine bulkhead latch that wholesales for P6.00. Each latch has variable operating costs of P3.50. Fixed operating costs are P60,000 per year. The firm pays P12,000 interest and preferred dividends of P8,500 per year. At this point, the firm is selling 30,000 latches per year and is taxed at a rate of 30%.

Compute for the DOL, DF, and DTL.

If the sales increased by 25%, by how much is the increase or decrease in the EPS?

If the sales decreased by 20%, by how much is the increase or decrease in the operating profit?

Problem 7

Medallion Cooling Systems, Inc., has total assets of P10,000,000, EBIT of P2,000,000, and preferred dividends of P200,000 and is taxed at a rate of 30%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

Capital structure debt ratio Cost of debt, rd Number of common stock shares Required return, rs

0% 0% 200,000 12%

15% 8 170,000 13

30% 9 140,000 14

45% 12 110,000 16

60% 15 90,000 20

Choose the optimal capital structure. Justify your choice