The Nealon Manufacturing Company, Inc., is in the midst of negotiations to acquire a plant in Fargo, North Dakota. The company CFO, James Nealon, is the son of the founder and CEO of the company and the heir apparent to the CEO position, so he is very concerned about making such a large commitment of money to the new plant. The cost of the purchase is $40 million, which is roughly one-half the size of the company today. To begin his analysis, James has launched the firms very first cost-of-capital estimation. The companys current balance sheet, restated to reflect market values, has been converted to percentages as follows: Nealon Manufacturing Company Inc., Type of Financing Honds (89, 51,000 par, 30-yea maturity) Preferred stock (5,000 shares outstanding $50 par. $1.50 dividend) The company paid dividends to its common stockholders of $1.75 per share last year, and the projected rate of annual growth in dividends is 7 percent per year for the indefinite future. Nealons common stock trades over the counter and has a current market price of $35 per share. In addition, the firms bonds have an AA rating. Moreover, AA bonds are currently yielding 7 percent. The preferred stock has a current market price of $19 per share. a. If the firm is in a 34 percent tax bracket, what is its weighted average cost of capital? b. In the analysis done so far, we have not considered the effects of flotation costs. Assume now that Nealon is raising a total of $40 million using the above financing mix. New debt financing will require that the firm pay 50 basis points (i.e., one-half a percent) in issue costs, the preferred stock issue will require flotation costs of 200 basis points, and the common stock issue will require flotation costs of 500 basis points. i. What are the total flotation costs the firm will incur to raise the needed $40 million? ii. How should the flotation costs be incorporated into the analysis of the $40 million investment the firm plans to make?

Type of Financing Honds (89, 51,000 par, 30-yea maturity) Preferred stock (5,000 shares outstanding $50 par. $1.50 dividend) Common stock Total Percentage of Future Financing 38% 10% 100%