Question

A firm is planning next year's capital budget. It is at its optimal capital structure, which is 32% debit and 68%, common equity, and the company’s earnings in dividends are growing at a constant rate of 4%. The last dividends, D0, was $1.50, and the company’s stock currently sells at a price of $36 per share. The firm can raise debt at a 6% before-tax cost and is projecting net income to be $8,500,000 with a dividend payout ratio of 20%. It’s the firms issue not common stock, a 2% flotation cost will be incurred. The firms marginal tax rate is 21%.

If the company end up spending 8 million a new capital how much new common stock will be sold?

A $6,800,000

B $0 the firm has some retained earnings to use

C $1,369,000

D $5,440,000

E $2,000,000

Calculate WACC 2 in the MCC schedule

A 7.24%

B Non of these choices

C 7.18%

D 7.65%

E 7.13%

Answer 1

(1) New Common Stock sold will be $0 the firm has some retained earnings to use.

Calculation of New Common Stock Sold
Particular		Amount	Amount
Net Income		$        8,500,000
Dividend Payout	20%	$        1,700,000
Retained Earning			$        6,800,000
New Spending	100%		$        8,000,000
Debt	32%		$        2,560,000
From Retain Earning			$        5,440,000

Company have enogh retain earing to finance in new spending.

Assume : Here Assume that $8 Million use in 32:68 ratio of debt:equity or retain earning respectively.

WACC = A 7.24%

Calculation of cost of debt = I x (1-t) = 6% x(1-0.21) = 4.740%

Calculation of cost of equity = [ D1 / {P0 x (1-F) } ] + g

= [(1.50 x 1.04) / { 36 x (1-0.02) } ] + 0.04

= 0.04422 + 0.04000

= 0.08422 or 8.422%