Question

ACE MANUFACTURING COMPANY Cost of Capital The following information pertains to Anderson, Colson, and Emerson (ACE) Manufacturing Company 1. ACE has a target capital structure of 45% mon Equity Long Term Debt 155% 2, ACE has a corporate tax rate of 40% J. The company expects to earn net income available to common stockholders of $22,500,000 during the coming year. Their dividend payout ratio is 40% of $4.00 during the next year, and has a constant future growth The firm expects to pay a dividend rate of 7% ACE's common stock currently sells in the market for S50.00 per share. 4. The flotation cost to issue new common stock would be 10% of seling price. The outstanding issue has 15 years remaining until maturity and The bonds currently sell for S848.00. There will be 6. ACE has debt currently outstanding. pays an 8% annual coupon (par value s$1,OC, no flotation charge on the issue of new debt. Questions Equolly Weighted) A. What is the yield to maturity on ACE's outstanding debt? B. what coupon rate w ACE need to oner on newy issued debt ae. what is ACE's before-tax cost of new debtj? C When the company's tax rate s taken into consideration, what is their after-tax cost of new debt? o whe the ace ot eturn lost of retaned ernings) on AcE'S common stock using the owidend Discount Mode? E. Whut s the tims WACC using retained earmings as the equity component? f. incorporating flotation cost in the Dividend Discount Model, what is the firm's cost of newly issued common stock? G. What is the firm's WACC using newly issued common stock as the equity component? H. At what level of total capital raised wil the company have to issue new common stock (Le. what is the break point for retained earnings)?

Answer 1

1)	YTM	=	[C+(F-P)/n]/(F+P)/2
		=	[80+(1000-848)/15]/(1000+848)/2
		=	0.09754 or 9.754%
2)	New bonds should be issued at YTM =9.754%,if bonds aretobe sold at par
	This will be pre tax coupon
3)	After tax rate of new debt			=	9.754%*(1-0.4)
				5.85%
4)	Cost of Retained Earnings = (Upcoming year's dividend / stock price) + growth
			=	(4/50)+0.07
			=	0.08+0.07
			=	0.15 or 15%
5)	WACC		=	Cost of equity*weight +cost of debt(after tax)*weight
			=	(15%*0.45)+(5.85%*0.55)
			=	9.97%
6)	Cost of new equity		=	[Dividend/price*(1-Floatation cost)]+growth
			=	[4/{50*(1-0.1)}]+0.07
			=	0.1588 or 15.88%
7)	WACC		=	(15.88%*0.45)+(5.85%*0.55)
			=	10.36%
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