Question

The market value of JC Engineering (JCE) was $60,000,000 on October 1. JCE plans to raise capital of $30,000,000 to invest in new electronic vehicle projects. JCE’s current capital structure, shown below, is considered to be optimal.

Debt $30,000,000
Common equity 30,000,000
Total capital $60,000,000

New bonds will have an 8% coupon rate, and they will be sold at par. The price of common stock is $30 per share. The stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. The firm’s tax rate is 40%

a. In order to maintain the current capital structure, how much of the new investment must be financed by common stock? (5 Points)

b. Assuming there is enough cash flow for JCE to maintain its target capital structure without issuing additional shares of equity, what is its WACC? (5 Points)

Answer 1

A) Current capital structure is Debt and equity in equal ratio.Therefore to maintain current capial structure common equity financing will be $15,000,000 ( $30,000,000,*1/2)

B) Calculation of WACC

WACC = Kd * Wd + Ke * We

= 4.8*0.50 + 12 *0.50

= 8.40%

Here

Kd = I(1 -t) = 8(1- 0.40) = 4.80%

Ke = 12%

Wd = 45,000,000/9,000,000 =0.50

We = 45,000,000/9,000,000 =0.50