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accounting-ABC Manufacturing is going to introduce a new product line and to accomplish this




Question;ABC Manufacturing is going to introduce a new product line and to accomplish thisit has four projects analyzed in which it wants to invest a total of $100 million. Your job is tofind what it will cost to raise this amount of capital and based on the cost of capital determine which of theprojects should be accepted by the firm to invest in.INVESTMENTEXPECTED RETURNA $30,000,00010.00%The firms capital structure consists of:CAPITALDEBTPREFERRED STOCKCOMMON STOCKPROJECTSB $20,000,00014.00%PERCENTAGE30%10%60%Other information about the firm:CORPORATE TAX RATEC $25,000,00011.50%D $25,000,00016.00%FMVAMOUNT $15,000,000 $5,000,000 $30,000,000 $50,000,00030%DEBTCURRENT PRICE $1,050.00ANNUAL INTEREST6.00% CURRENT INTEREST PAID SEMIANNUALLYORIGINAL MATURITY25 YEARS, BUT NOW 20 YEARS LEFTMATURITY VALUE $1,000.00FLOTATION COSTINSIGNIFICANTMARKET YIELD PROJECTED: UP TO $20 MILLION9% ABOVE $20 MILLION12% 3 % additional premiumCURRENT PRICEPREFERRED $45.00LAST DIVIDEND (D0)FLOTATION COST $3.38 FIXED AT 7.5% OF PAR $1.50NEXT DIVIDEND (D1) $3.38CURRENT PRICELAST DIVIDEND (D0)RETAINED EARNINGSGROWTH RATE (g)FLOTATION COSTNEXT DIVIDEND (D1)COMMON $35.00 $1.00 $10,000,0009% $1.50 $1.090NOTE ? 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 theset 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?Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.Part aCurrent priceMaturity valueInterest paymentPayment periodsYield rateAnnual yieldKdKpKeCurrent Cost of capitalsix month rateannual rateCan't really use the current cost of capital since accepting any new projects will require issuing newPreferred stock requiring a rate higher than its current 7.5% yield.Part bUse your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%, =Knp preferred stockNew cost of capitalPart cIf the capital structure increases more thannew common stock will have to be issued to finance new projects since internally generated RE runs out,and the required return on common stock will increase as demanded by shareholders.Part dKne common stockIf you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%=New cost of capital


Paper#42213 | Written in 18-Jul-2015

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