The case for the cost of the capital, WACC, graph of MVC. The most problem is to understand the structure of the capital and to safe it as it is required in the task. (If we safe the structure, our capital rises from 252M to 881M...) I need extreme help!!!

CASO 39 Wyoming Energy Development, Inc. Cost of Capital In May 1991, Linda Bellich, a recent M.B.A graduate and newly appointed assistant to the comptroller of Wyoming Energy Development, Inc. (WED), was given a list of six new investment projects proposed for the following year. It was her job to analyze these projects and be prepared to present her ndings before the board of directors at its annual meeting to be held in 10 days. Wyoming Energy Development was founded in Laramie. Wyoming, in 1963 by Scott Heywood. WED gained recognition as a leading producer of high-quality coal, with the majority of its sales being made to Japan. During the rapid economic expansion of Japan in the 1960s, demand for coal and other energy products boomed, and WED's sales grew rapidly. As a result of this rapid growth and recognition of new opportunities in the energy market, WED began to diversify its product line. While retaining its emphasis on coal production, it expanded operations to include uranium mining and the production of electrical generators, and nally, it went into all phases of energy production. By 1990, WED's sales had reached the $140 million level, with net prot after taxes attaining a record $6.7 million. As WED expanded its product line in the early 1980s, it also formalized its capital budgeting procedure. Until 1982, capital investment projects were selected primarily on the basis of the average return on investment calculations, with individual departments submitting these calculations for projects falling within their division. In 1986, this procedure was replaced by one using present value as the decision-making criterion. This change was made to incorporate cash ows rather than accounting prots into the decision- making analysis, in addition to adjusting these ows for the time value of money. At that time, the cost of capital for WED was determined to be 4.36 percent, which has been used as the discount rate for the past ve years. This rate was determined by taking a weighted average of the costs WED had incurred in raising funds from the capital markets over the previous 10 years. It had originally been Bellich's assignment to update this rate over the most recent 10 year period and determine the net present value of all the proposed investment opportunities using this newly calculated gure. However, she objected to this procedure, stating that while this calculation gave a good estimate of "the past cost" of capital, changing interest rates and stock prices made this calculation of little value in the present. Bellich suggested that current costs of raising nds in the capital markets be weighted by their percentage makeup of the capital structure. This proposal was reviewed enthusiastically by the comptroller of WED, and Bellich was given the assignment of recalculating WED's cost of capital and providing a written report for the nancial board of directors explaining and justifying this calculation. To determine a weighted average cost of capital for WED, it was necessary for Linda Bellich to examine the costs associated with each source of funding used. In the past, the largest sources of funding had been the issuance of new common stock and internally generated funds. Through conversations with the comptroller and other members of the board of directors, Bellich learned that the rm, in fact, wished to maintain its current nancial structure since it is in accordance with the book value weights shown in Exhibit 1. She thher determined that the strong growth patterns that WED had exhibited over the past 10 years were expected to continue indenitely because of the dwindling supply of U.S. and Japanese domestic oil and the growing importance of, and U.S. and Japanese dependence on, coal and other alternative energy resources. Through lrther investigation, Bellich learned that WED could issue additional shares of common stock, which had a par value of $25 per share and were selling at a current market price of $45. The expected dividend for the next period would be $2 per share, with expected growth at a rate of 6 percent per year for the foreseeable future. The underwriting commission paid to WED's investment banker would amount to$2 per share and would be for insuring the issue against the risk of adverse market uctuations in the stock's selling price during the distribution process, in addition to performing the function of actually selling the security and providing advice as to the timing and pricing of the issue. EXHIBIT 1 Wyoming Energy Development, Inc. Balance Sheet For Year Ending April 30, 1991. Assets 1991 Cash $ 9,000.000 Accounts receivable 31,000.000 Inventories 12,000.000 Total current assets $ 52,000.000 Net xed assets 193,000.000 Goodwill 7,000.000 Total assets 5 252,000.000 Liabilities and Equity Accounts payable $ 850.000 Current debt 10,000.000 Accrued taxes 1,150.000 Total current liabilities $ 12,000.000 Long-term debt 72,000.000 Preferred stock 43,000,000 Common stock 1 14,000.000 Retained earnings 11,000.000 Total liabilities and equity mm Preferred stock at 6 percent also could be issued with the help of an investment banker at $97 per share with a par value of $100 per share. Of this $97, 3.1 percent would go to the investment banker for his help in marketing the issue, with the remainder of the inds going to WED. Finally, Bellich learned that it would be possible for WED to raise an additional $1 million through a one-year loan from WED's Chicago bank at 9 percent. Any amount raised over $1 million would cost WED 14 percent., Short-term debt has always been used by Wyoming to nance capital expenditures, and as WED grows, it is expected to maintain its proportion in the capital structure to support capital expansion. Also, $6 million could be raised through a bond issue with 30 years' maturity with a 10 percent coupon at 98 percent of face value. On this issue, 2 percent of the face value would be charged as an underwriting commission. If it became necessary to raise more Jnds via long-term debt, $3 million more could be accumulated through the issuance of additional 30 year bonds sold at 95 percent of face value, with the coupon rate being raised to 11 percent and 2 percent of the face value being charged as an underwriting commission. While any additional funds raised via long-term debt would necessarily have a 30-year maturity with a 14 percent coupon yield and be sold at 95 percent of face value, 2 percent of this face value would be charged as an underwriting fee. Here again, this fee would go to the investment banker for his help in marketing the issue. In the past, WED has calculated a weighted average of these sources of funds to determine its cost of capital. In discussions with the current comptroller, the point was raised that while this served as an appropriate calculation for externally generated nds, it did not take into account the fact that much of the funds used for capital expenditures by WED were internally generated. For example, WED is expected to produce $5 million in depreciation- generated funds in addition to retaining $4 million of its earnings during the coming period. The comptroller agreed that there should be some cost associated with retained earnings financing incorporated into the calculations, but depreciation charges should not be included since they, as opposed to all other nancing methods, do not appear on the liability side of the balance sheet. Although Bellieh was not completely convinced by the comptroller's logic, she continued with her work. QUESTIONS 1.- Assume that WED whishes to continue with the existing capital structure. What is the average cost of capital? (Use a 50 percent corporate tax rate for WED.) 2.- Graph WED's average cost of capital: again assume that WED desires to maintain its current capital structure