Question

In: Accounting

On January 1, 2019, the total assets of the McGarvey Company were $270 million. The first...

On January 1, 2019, the total assets of the McGarvey Company were $270 million. The first present capital structure, which follows, is considered optimal. Assume that they have no short-term debt. Long-term debt $135,000,000 Common Equity 135,000,000 Total Liabilities and Equity $270,000,000 New bonds will have a 10% coupon rate and will be sold at par. Common stocks are currently selling at $60 a share, can be sold to net the company $54 a share. Stockholders required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected growth rate of 8% (the next expected dividend is $2.4 so $2.4/$60 = 4%). Retained earnings are estimated to be $15 million. The marginal corporate tax rate is 20%. Assuming that all asset expansion (Gross expenditure plus fixed assets plus related working capital) is included in the capital budget, the amount of the capital budget, ignoring depreciation, is 160,000,000

1. To maintain the present capital structure, how much capital budget must McGarvey finance by equity?

2. How much of the new equity funds needed will be generated internally and externally?

3. Calculate the cost of each of the equity components.

4. At what level of capital expenditure will there be a break in Dexter's Marginal Cost of Capital schedule?

5. Calculate WACC.

Show some step by step working please

Solutions

Expert Solution

1.Present capital structure is Long-term debt 50% & Equity 50% ( $ 135 mln. Of the total $ 270 mln.)
so, the$ total of the capital budget , to be financed by equity= $ 160 mln./2= $ 80 mln.
2. Amount of the new equity funds to be generated internally and externally
Given that the
Retained earnings are estimated to be $15 million
so, internally generated equity = $ 15 mln. &
externally generated equity =(80-15)= $ 65 mln.  
3. Cost of each of the equity components
Cost of retained earnings, kre---12% (with no new issue)
Cost of equity-new issue, ke= ---(2.4/54)+8%=12.44%
After-tax cost of new debt, kd = Before-tax cost*(1-Tax rate)
ie. 10%*(1-20%)= 8.00%
5. WACC=(wt.re*kre)+(wt.e*ke)+(wtd*kd)
ie.(15/160*12%)+(65/160*12.44%)+(80/160*8%)=
10.18%
4.Break-point in marginal cost of capital (level of CAPEX)
Share of retained earnings= $ 15 ml.. Maximum , in any expenditure
Currently, its wt. in the capital structure= 15 mln./160 mln= 9.38%
The capital expenditure , if that requires more than $ 15 mln. From retained earnings ---
will necessitate issue of new equity at 12.44%
so that CAPEX which requires a jump in the WACC, will be the break point
so, $ 15 equity +$ 15 debt= (50% each)= $ 30 mln.is the break point for MCC
CAPEX above 30 mln. Will require issue of new equity, which will cost its wt.*12.44% ,additionally

Related Solutions

On 1 January 2019, the total assets of the Dexter Company were $270 million. The company’s...
On 1 January 2019, the total assets of the Dexter Company were $270 million. The company’s present capital structure, which follows, is considered to be optimal. Assume that there is no short-term debt. Long-term debt $ 135,000,000 Ordinary equity $135,000,000 Total liabilities and Equity $270,000,000 The company is considering an investment in a new capital investment project. Assuming that all asset expansion (gross expenditures for fixed assets plus related working capital) is included in the capital budget, the dollar amount...
On January 1 , 2009 the total assets of the Shipley Company were $ 180 million.During...
On January 1 , 2009 the total assets of the Shipley Company were $ 180 million.During the year, the company plans to raise and invest $ 90 million.The firm’s present capital structure is considered optimal.Assume that there is no short term debt.            Long term debt                                 90,000,000            Common Equity                                90,000,000            Total Liabilities and Equity             180,000,000 New bonds will have a coupon rate of 10% and will sell at par. Common stock,currently selling at $ 40 a share can...
At year-end 2019, total assets for Arrington Inc. were $1.8 million and accounts payable were $425,000....
At year-end 2019, total assets for Arrington Inc. were $1.8 million and accounts payable were $425,000. Sales, which in 2019 were $2.90 million, are expected to increase by 30% in 2020. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $390,000 in 2019, and retained earnings were $445,000. Arrington...
You have the following information for Butterfly Inc. US $million 2019 2018 Intangible assets 270 250...
You have the following information for Butterfly Inc. US $million 2019 2018 Intangible assets 270 250 Property, plant and equipment 180 170 Inventory 120 120 Operating liabilities 180 150 Interest-bearing debt 125 125 Equity 265 265 US $million 2019 Sales revenue 200 Operating expenses 51 Depreciation & amortisation 30 Interest expense 9 Taxation 33 Profit for the year 77 The company has no interest income. Calculate the 2019 FCF (free cash flow) for Butterfly Inc. c) Butterfly Inc’s interest bearing...
The Malia Corporation had sales in 2019 of $64 million, total assets of $42 ​million, and...
The Malia Corporation had sales in 2019 of $64 million, total assets of $42 ​million, and total liabilities of $ 21 million. The interest rate on the​ company's debt is 6.6 percent and its tax rate is 21 percent. The operating profit margin was 12 percent. What were the​ company's operating income and net​ income? What was the operating return on assets and return on​ equity? Assume that interest must be paid on all of the debt.
Paladin Furnishings generated $2 million in sales during 2019,and its year-end total assets were $1.2...
Paladin Furnishings generated $2 million in sales during 2019, and its year-end total assets were $1.2 million. Also, at year-end 2019, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accrued liabilities. Looking ahead to 2020, the company estimates that its assets must increase by $0.60 for every $1.00 increase in sales. Paladin's profit margin is 3%, and its retention ratio is 40%. How large of a sales increase can the company...
Paladin Furnishings generated $2 million in sales during 2019, and its year-end total assets were $1.6...
Paladin Furnishings generated $2 million in sales during 2019, and its year-end total assets were $1.6 million. Also, at year-end 2019, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accrued liabilities. Looking ahead to 2020, the company estimates that its assets must increase by $0.80 for every $1.00 increase in sales. Paladin's profit margin is 4%, and its retention ratio is 45%. How large of a sales increase can the company...
eBook Problem Walk-Through At year-end 2019, total assets for Arrington Inc. were $1.8 million and accounts...
eBook Problem Walk-Through At year-end 2019, total assets for Arrington Inc. were $1.8 million and accounts payable were $340,000. Sales, which in 2019 were $2.00 million, are expected to increase by 20% in 2020. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $435,000 in 2019, and retained earnings...
At year-end 2016, a company total assets were $1.8 million, and its accounts payable were $350,000....
At year-end 2016, a company total assets were $1.8 million, and its accounts payable were $350,000. Sales, which in 2016 were $2.8 million, are expected to increase by 30% in 2017. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Company typically uses no current liabilities other than accounts payable. Common stock amounted to $360,000 in 2016, and retained earnings were $260,000. Company has arranged to sell $120,000 of new common stock in 2017...
1. At year-end 2016, total assets for Arrington Inc. were $1.6 million and accounts payable were...
1. At year-end 2016, total assets for Arrington Inc. were $1.6 million and accounts payable were $365,000. Sales, which in 2016 were $2.6 million, are expected to increase by 30% in 2017. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $410,000 in 2016, and retained earnings were $255,000....
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT