(Mini Case) The balance sheet that follows indicates the capital structure for Nealon Inc

Assignment:
Weighted Average Cost
Complete the Mini Case on page 368 and submit to instructor. In parts "a" and "b" clearly label the calculation of the required ratios and solve using Excel. Use formulas to calculate the ratios and format the cells to insert a comma if there is more than three numbers. Round to two decimal places. No narrative analysis is called for, so clearly label the calculations so that management will be able to comprehend them.

Mini Case
The balance sheet that follows indicates the capital structure for Nealon Inc. Flotation costs are (a) 15 percent of market value for a new bond issue, and (b) $2.01 per share for preferred stock. The dividends for common stock were $2.50 last year and are projected to have an annual growth rate of 6 percent. The firm is in a 34 percent tax bracket. What is the weighted average cost of capital if the firm’s finances are in the following proportions?
TYPE OF FINANCING PERCENTAGE OF FUTURE FINANCING
Bonds (8%, $1000 par, 16-year maturity) 38%
Preferred Stock (5,000 shares outstanding, $50 par, $1.50 dividend) 15%
Common Equity 47%
Total 100%

a. Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e. retained earnings) available such that the firm does not plan to issue new common stock. Calculate the firm’s weighted average cost of capital.
b. In part a we assumed that Nealon would have sufficient retained earnings such that it would not need to sell additional common stock to finance its new investments. Consider the situation now, when Nealon’s retained earnings anticipated or the coming year are expected to fall short of the equity requirement of 47 percent of new capital raised. Consequently, the firm foresees the possibility that new common shares will have to be issued. To facilitate the sale of shares, Nealon’s investment banker has advised management that they should expect a price discount of approximately 7 percent, or $2.45 per share. Under these terms, the new shares should provide net proceeds of about $32.55. What is Nealon’s cost of equity capital when new shares are sold, and what is the weighted average cost of the added funds involved in the issuance of new shares?


Click here for the solution: (Mini Case) The balance sheet that follows indicates the capital structure for Nealon Inc

Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure

Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure.

debt ratio pretax cost cost of equity weighted average
[B/(B+E)] of debt cost of capital

0.00 12.00
0.15 13.00 11.68
0.30 8.00 14.50
0.45 16.50 11.775
14.00 19.00 12.64

The company’s income tax rate is 40 percent.

a. Fill in the missing entries in the table.
b. Determine the capital structure (i.e., debt ratio) that minimizes the firm’s weighted average cost of capital


Click here for the solution: Colorado Coal Company has estimated the costs of debt and equity capital (with bankruptcy and agency costs) for various proportions of debt in its capital structure

Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure

Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure.

Debt Fractions ki ke with financial ke with financial distress w/o agency costs distress with agency costs
0.00 12.00% 12.00%
0.10 4.80% 12.05% 12.05%
0.30 4.90% 12.10% 12.20%
0.40 5.00% 12.20% 12.60%
0.45 5.20% 12.40% 13.40%
0.50 5.70% 12.80% 14.80%
0.60 7.00% 15.00% 18.00%

a. Based on these data, determine the company’s optimal capital structure (i) with financial distress costs and without agency costs and (ii) with financial distress and agency costs.
b. Suppose the company’s actual capital structure is 50 percent debt and 50 percent equity. How much higher is ka at this capital structure than at the optimal value of ka with financial distress and agency costs?

c. Is it necessary in practice for the company to know precisely its optimal capital structure? Why?

Click here for the solution: Piedmont Instruments Corporation has estimated the following costs of debt and equity capital for various fractions of debt in its capital structure