Taunton Construction Inc.$\text{'}$s capital situation is described as follows:

Debt: The firm issued $10,00025-$year bonds$10$ years ago at their par value of $$1,000.$ The bonds carry a coupon rate of $14\%$ and are now selling to yield $10\%.$

Preferred Stock: $30,000$ shares of preferred stock were sold six years ago at a par value of $$50.$ The shares pay a dividend of $$6$ per year. Similar preferred issues are now yielding $9\%.$

Equity: Taunton was initially financed by selling $2$ million shares of common stock at $$12.$ Accumulated retained earnings are now $$5$ million. The stock is currently selling at $$13\mathrm{.}25.$

Taunton's Target Capital Structure is as follows:

Debt $30\mathrm{.}0\%$

Preferred Stock $5\mathrm{.}0\%$

Common Equity $65\mathrm{.}0\%$

$100\mathrm{.}0\%$

Other information:

$$ Taunton's marginal tax rate $($state and federal$)$ is $40\%.$

$$ Flotation costs average $12\%$ for common and preferred stock.

$$ Short$-$term treasury bills currently yield $7\mathrm{.}5\%.$

$$ The market is returning $12\mathrm{.}5\%.$

$$ Taunton's beta is $1\mathrm{.}2.$

$$ The firm is expected to grow at $6\%$ indefinitely.

$$ The last annual dividend paid was $$1\mathrm{.}00$ per share.

$$ Taunton expects to earn $$5$ million next year.

$$ The firm can borrow an additional $$2$ million at rates similar to the market return on its old debt. Beyond that lenders are expected to demand returns in the neighborhood of $14\%.$

$$ Taunton has the following capital budgeting projects under consideration in the coming year. These represent its investment opportunity schedule $($IOS$).$

Capital Cumulative

Project IRR Required Cap. Req.

A $15\mathrm{.}0\%$ $$3$M $$3$M

B $14\mathrm{.}0\%$ $$2$M $$5$M

C $13\mathrm{.}0\%$ $$2$M $$7$M

D $12\mathrm{.}0\%$ $$2$M $$9$M

E $11\mathrm{.}0\%$ $$2$M $$11$M

a$.$ Calculate the firm's capital structure based on book and market values and compare with the target capital structure. Is the target structure a reasonable approximation of the market value based structure? Is the book structure very far off?

b$.$ Calculate the cost of debt based on the market return on the company's existing bonds.

c$.$ Calculate the cost of preferred stock based on the market return on the company's existing preferred stock.

d$.$ Calculate the cost of retained earnings using three approaches, CAPM, dividend growth, and risk premium. Reconcile the results into a single estimate.

e$.$ Estimate the cost of equity raised through the sale of new stock using the dividend growth approach.

f$.$ Calculate the WACC using equity from retained earnings based on your component cost estimates and the target capital structure.

g$.$ Where is the first breakpoint in the MCC $($the point where retained earnings runs out$)?$ Calculate to the nearest $$\mathrm{.}1$M$.$

h$.$ Calculate the WACC after the first breakpoint.

i$.$ Where is the second breakpoint in the MCC $($the point at which the cost of debt increases.$)$ Why does this second break exist? Calculate to the nearest $$\mathrm{.}1$M$.$

j$.$ Calculate the WACC after the second break.

k$.$ Plot Taunton's MCC$.$

l$.$ Plot Taunton's IOS on the same axes as the MCC$.$ Which projects should be accepted and which should be rejected? Do any of those rejected have IRRs above the initial WACC? If so$,$ explain in words why they're being rejected.

m$.$ What is the WACC for the planning period?

n$.$ Suppose project E is self$-$funding in that it comes with a source of its own debt financing. A loan is offered through an equipment manufacturer at $9\%.$ The cost of the loan is $9\%(1-$T$)=5\mathrm{.}4\%.$

Should project E be accepted under such conditions?