Scribd
Upload
89 views

Assignment

The document provides information on the capital structure and projected financing needs of Nealon Inc. It indicates that Nealon currently finances 38% of its capital through bonds, 15% through preferred stock, and 47% through common equity. However, Nealon's retained earnings may not be sufficient to finance the 47% equity requirement, so it may need to issue new common shares. The summary calculates Nealon's weighted average cost of capital both if it finances the equity internally through retained earnings (10.08%) and if it finances through an external issue of common stock (10.35%) which would incur additional flotation costs.

Uploaded by

Mona Vimla
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
89 views

Assignment

The document provides information on the capital structure and projected financing needs of Nealon Inc. It indicates that Nealon currently finances 38% of its capital through bonds, 15% through preferred stock, and 47% through common equity. However, Nealon's retained earnings may not be sufficient to finance the 47% equity requirement, so it may need to issue new common shares. The summary calculates Nealon's weighted average cost of capital both if it finances the equity internally through retained earnings (10.08%) and if it finances through an external issue of common stock (10.35%) which would incur additional flotation costs.

Uploaded by

Mona Vimla
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
You are on page 1/ 2

The balance sheet that follows indicates the capital structure for Nealon. Inc.

Flotation costs are (a) 15 percent of market value for a new bond issue, and (b) $2.01 per share for preferred stock. The dividends for common stock were $2.50 last year an are projected to have an annual growth rate of 6 percent. The firm is in a 34 percent tax bracket.. what is the weighted average cost of capital if the firms finances are in the following proportions? TYPE OF FINANCING Bonds [8%, $1,000 par, 16 year maturity] Preferred stock [5,000 shares outstanding, $50par, $1.50 dividend] Common equity Total PERCENTAGE OF FUTURE FINANCING 38% 15% 47% 100%

a. Market prices are $1.0.35 for bonds, $19 for preferred stock and $35 for common stock. There will be sufficient internal common equity funding (i.e., retained earnings) available suck that the firm does not plant to issue new common stock. b. In part a we assumed that Nealon would have sufficient retained earnings such that it would not need to sell additional common stock to finance its new investments. Consider the situation now, when Nealons retained earnings anticipated for the coming year are expected to fall short of the equity requirement of 47 percent of new capital raised. Consequently, the firm foresees the possibility that new common shares will have to be issued. To facilitate the sale of shares, Nealons investment banker has advised management that they should expect a price discount of approximately 7 percent, or $2.45 per share. Under these terms, the new shares should provide net proceeds of about $32.55. What is Nealons cost of equity capital when new shares are sold, and what is the weighted average cost of the added funds involved in the issuance of new shares?

a. Weighted Cost of Capital Cost of Debt: $1,035 (1 - .15) = $879.75 = NP0 $879.75 kd = =

t = 1 (1 + k d )

16

$80
t

$1,000 (1 + k d )16

9.49% = 6.26%

After-tax cost of debt = 9.51% (1 - .34)

Cost of Preferred Stock: kps = D NP0 = $1.50 ($19 - $2.01) = 8.83% Cost of Internal Common Funds: kcs = D1 P0 + g

= =

$2.50(1 + 0.06) + 0.06 $35 .1357 = 13.57%

Weighted Cost of Capital (K wacc) using internal common funds only:

Bonds Preferred Stock New Common Stock

Weights 0.38 0.15 0.47 1.00

Costs 6.26% 8.83% 13.57%

Weighted Costs 0.0238 0.0132 0.0638 .1008 or 10.08%

b.

Raising external common equity Cost of External Common Stock: K ncs = = =

D1 +g NPo
$2.50(1 + 0.06) + 0.06 $35 $1.21 .1414 = 14.14%

Weighted Cost of Capital (K wacc) using external common funds only:

Bonds Preferred Stock New Common Stock

Weights 0.38 0.15 0.47 1.00

Costs 6.26% 8.83% 14.14%

Weighted Costs 0.0238 0.0132 0.0665 .1035 or 10.35%

You might also like