LEI finance
Exercise
Cost of Capital
1. Lancaster Engineering Inc. (LEI) has the following capital structure, which is considers to be optimal:
Debt 25%
Preferred stock 15
Common equity 60 100% LEI’s expected net income this year is $34,285.72, its established dividend payout ratio is 30 percents, its federal-plus-state tax rate is 40 percent, and investors expect earnings and dividends to grow at a constant rate of 9 percent in the future. LEI paid a dividend of $3.60 per share last year, and its stock currently sells at a price of $54 per share. LEI can obtain new capital in the following ways:
Preferred: New preferred stock with a dividend of $11 can be sold to the public at a price of $95 per share.
Debt: Debt can be sold at an interest rate of 12 percent.
a. Determine the cost of each capital structure component.
b. Calculate the WACC.
c. LEI has the following investment opportunities that are typical average-risk projects for the firm:
Project
Cost at t = 0
Rate of Return
A
$ 10,000
17.4%
B 20,000
16.0
C 10,000
14.2
D 20,000
13.7
E 10,000
12.0
Which projects should LEI accept? Why? [2(382)]
2. The Heuser Company’s currently outstanding 10 percent coupon bonds have a yield to maturity of 12 percent. Heuser believes it could issue at par new bonds that would provide a similar yield to maturity. If its marginal tax rate is 35 percent, what is Heuser’s aftert-tax cost of debt? [2(383)]
3. Trivoli Industries plans to issue some $100 par preferred stock with an 11 percent dividend. The stock is selling on the market for $97.00, but Trivoli must pay flotation costs of 5 percent of the market price, so the net price that firm will receive is $92.15 per share. What is Trivoli’s cost of preferred stock with flotation considered? [2(383)]
4. Zwing-Zook Enterprises has a beta of 1.45. The risk-free rate is 6 percent and the expected return on the market portfolio is 10 percent. The company
Cost of Capital
1. Lancaster Engineering Inc. (LEI) has the following capital structure, which is considers to be optimal:
Debt 25%
Preferred stock 15
Common equity 60 100% LEI’s expected net income this year is $34,285.72, its established dividend payout ratio is 30 percents, its federal-plus-state tax rate is 40 percent, and investors expect earnings and dividends to grow at a constant rate of 9 percent in the future. LEI paid a dividend of $3.60 per share last year, and its stock currently sells at a price of $54 per share. LEI can obtain new capital in the following ways:
Preferred: New preferred stock with a dividend of $11 can be sold to the public at a price of $95 per share.
Debt: Debt can be sold at an interest rate of 12 percent.
a. Determine the cost of each capital structure component.
b. Calculate the WACC.
c. LEI has the following investment opportunities that are typical average-risk projects for the firm:
Project
Cost at t = 0
Rate of Return
A
$ 10,000
17.4%
B 20,000
16.0
C 10,000
14.2
D 20,000
13.7
E 10,000
12.0
Which projects should LEI accept? Why? [2(382)]
2. The Heuser Company’s currently outstanding 10 percent coupon bonds have a yield to maturity of 12 percent. Heuser believes it could issue at par new bonds that would provide a similar yield to maturity. If its marginal tax rate is 35 percent, what is Heuser’s aftert-tax cost of debt? [2(383)]
3. Trivoli Industries plans to issue some $100 par preferred stock with an 11 percent dividend. The stock is selling on the market for $97.00, but Trivoli must pay flotation costs of 5 percent of the market price, so the net price that firm will receive is $92.15 per share. What is Trivoli’s cost of preferred stock with flotation considered? [2(383)]
4. Zwing-Zook Enterprises has a beta of 1.45. The risk-free rate is 6 percent and the expected return on the market portfolio is 10 percent. The company