Saint Leo Manufacturing is going to introduce a new product line and to accomplish this it has four projects analyzed in which it wants to invest a total of $100 million. Your job is to find what it will cost to raise this amount of capital and based on the cost of capital determine which of the projects should be accepted by the firm to invest in. PROJECTS A B C D INVESTMENT $30,000,000 $20,000,000 $25,000,000 $25,000,000 EXPECTED RETURN 10.00% 14.00% 11.50% 16.00% The firms capital structure consists of: FMV CAPITAL PERCENTAGE AMOUNT DEBT 30% $15,000,000 PREFERRED STOCK 10% $5,000,000 COMMON STOCK 60% $30,000,000 $50,000,000 Other information about the firm: CORPORATE TAX RATE 35% DEBT CURRENT PRICE $900.00 ANNUAL INTEREST 9.00% CURRENT INTERST PAID SEMIANNUALLY ORIGINAL MATURITY 25 YEARS, BUT NOW 20 YEARS LEFT MATURITY VALUE $1,000.00 FLOTATION COST INSIGNIFICANT MARKET YIELD PROJECTED: UP TO $20 MILLION 9% ABOVE $20 MILLION 12% 3 % additional premium PREFERRED CURRENT PRICE $50.00 LAST DIVIDEND (D0) $5.00 FIXED AT 10% OF PAR FLOTATION COST $2.00 NEXT DIVIDEND (D1) $5.00 COMMON CURRENT PRICE $33.00 LAST DIVIDEND (D0) $1.50 RETAINED EARNINGS $16,000,000 GROWTH RATE (g) 9% FLOTATION COST $3.00 NEXT DIVIDEND (D1) $1.635 NOTE - Once retained earnings is maxed out new common stock will need to be issued. Any preferred stock would be new preferred stock. You may want to review case in chapter 11. REQUIRED: In all of the required parts one part builds on the previous part. If you can't do a part use the set of other numbers to solve the next part. a. What is the current Kd, Kp and Ke assuming no new debt or stock? b. Since any new capital investment will require issuing new perferred stock, what would the the new returns be preferred stock (knp) and the new cost of capital? c. What amount of increase (marginal cost of capital) in capital structure will the firm run out of retained earnings and be forced to issue new common stock? d. If new common stock has to be issued what will the new return required be (Kne) and the new cost of capital?
Part a Current price Maturity value Interest payment Payment periods Yield rate Annual yield Kd Kp Ke Current Cost of capital
Part b Use your solutions in part a to do this part, but if you couldn't complete part a assume Kd=7%, Kp=11%, and Ke=14%. Knp preferred stock New cost of capital Part c If the capital structure increases more than
Part d Kne common stock If you could not come up with the Kne returns do the cost of captial assuming Kd=7%, Knp=12%, and Ke=14%. New cost of capital
