The Ritz Carlson would like to calculate its cost of debt.

It sells annual-coupon paying bonds with 9 year maturity, $1,000 par value, and 12% coupon rate for a price of $1,045.

The Ritz Carlson must pay 5.5% of par value in flotation costs and it has a tax rate of 35%.

a. Calculate the cost of debt for a 35% tax rate. Keep 2 decimal places for percentages for full credit (0.00% or 0.0000).

b. What would happen to The Ritz Carlsons cost of debt if the tax rate increases to 40%? Keep 2 decimal places for percentages for full credit (0.00% or 0.0000).

c. What can we conclude about the relationship between cost of debt and the tax rate? What explains this relationship?

The Ritz Carlson would like to calculate the cost of preferred stock and common stock.

The Ritz Carlson sells preferred stock for $72.00 per share, and it pays a $3.50 underwriting fee per share.

The dividend for preferred stock is $7.45.

d. Calculate the cost of preferred stock.

The Ritz Carlson sells common stock for $125.00 per share.

The hotel company pays $5.00 per share in underpricing costs and $3.50 per share in flotation costs.

It expects to pay dividends of $12.72 next year. Its dividends have been growing at an annual rate of 3% and it expects this rate to continue in the foreseeable future.

f. Calculate the cost of common stock equity (retained earnings).

Refer to the information in the previous questions to calculate the cost of new common stock equity.

The Ritz Carlson has a capital structure of 35% debt, 15% preferred stock, and 50% common stock equity. It estimates that it will have $2,500,000 in retained earnings to invest next year. It will only issue new common stock once it has used up its retained earnings.

1. What level of investment will the Ritz Carlson take on before it issues new common stock equity?

2. Calculate WACC for both retained earnings and common stock equity and indicate which The Ritz Carlson would use to evaluate its projects.

The Ritz Carlson is evaluating the following projects for investment.

	Swimming Pool	Golf Course	Restaurant Area	Landscaping
Cost	$500,000	$500,000	$500,000	$500,000
Expected return	9.50%	11.50%	14.20%	10.30%
Least Cost Financing Source	Debt - 8%	Equity - 11%	Equity - 11%	Debt - 8%

The Ritz Carlsons summer intern has suggested taking all projects because the cost of their best (least cost) financing source is lower than their expected return. How would you respond to the intern?

Based on your calculations above, what projects, if any, should The Ritz Carlson invest in?