The company has issued 1 million shares that currently sell for $20 per share. Investors expect to earn 6% above the companys bond yield on average. The company has issued 30,000 bonds that offer an annual coupon rate of 5%, a face value of $1,000 and have five years remaining until maturity. They currently sell for $1,000 per bond. The corporate tax rate is 25%. The company has paid out all of its earnings as dividends for many years.

The Project

The project has an up-front cost of $5,000,000 and will return $2,000,000/year for 4 years with the first payment coming in year 3.

(A) Determine the companys current capital structure and its current WACC.

(B) Based on the NPV, should the company do the project?

(C) Discuss arguments for and against using debt or equity.

(D) To the extent retained earnings are used by this company, discuss the potential implications of the change to dividend policy.

(E) What do you think the effect of an increased use of debt would be on the companys cost of debt, cost of equity and WACC?