Question

ou are provided the following information:

Capital Structure:

Debt                                         $    60000

Equity                                       $   180000

The firm sold 50 year; $ 1000 face value, 5% bonds 10 years ago. These bonds trade at $ 930. You expect the yield on these bonds to be a good proxy for the cost of issuing new bonds.

The shares trade at $ 20; the growth rate is 6%. Dividends paid last year - $ 1.00.

The firm has a 30% tax rate.

Kemper, Goebel & Benkato, Investment Bankers have informed you that new shares can be sold with a 10% transaction cost.

New 50 year bonds can be sold. The firm can collect:

$ 0          --             $      120000            6%

The firm added $ 180000 to retained earnings last year.

As the intern, compute the cost of capital {WACC} for the CFO.

f) How much can you borrow with the amount you have added to retained earnings last year? Note: NO change in capital structure.

g) Compute the WACC IF your CFO wants a ‘NEW’ capital structure with 60% debt. [use old costs]

h) What is the cost of equity when new shares are sold?

i. Compute the WACC if you borrow over $ 60001 with the ‘OLD’ capital structure.