You work for the Berea Amalgamated Products Company that produces coloring books, velvet paintings and other fine arts.
You are proposing a new venture, to branch out into figurine animals and cartoon characters but this will require new equipment and a capital outlay.
You need to explore the financials before further researching unto a complete recommendation relative to this proposed venture.
Pertinent financial information is below briefly stated:
| Cash | 2,000,000 | Accounts Payable and Accruals | 18,000,000 |
| Accounts Receivable | 28,000,000 | Notes Payable | 40,000,000 |
| Inventories | 42,000,000 | Long-Term Debt | 60,000,000 |
| Preferred Stock | 10,000,000 | ||
| Net Fixed Assets | 133,000,000 | Common Stock | 77,000,000 |
| Total Assets | 205,000,000 | Total Claims | 205,000,000 |
Last year’s sales were $225,000,000.
The company has 60,000 bonds (par value $1,000.; 30-year life) with 15 years until maturity. The bonds carry a 10 percent annual coupon, and are currently selling for $874.78.
You also have 100,000 shares of $100 par, 9% dividend perpetual preferred stock outstanding. The current market price is $90.00. Any new issues of preferred stock would incur a $3.00 per share flotation cost.
The company has 10 million shares of common stock outstanding with a currently price of $14.00 per share. The stock exhibits a constant growth rate of 10 percent. The last dividend (D0) was $.80. New stock could be sold with 15% flotation costs.
The risk-free rate is currently 6 percent, and the rate of return on the stock market as a whole is 14 percent. Your stock’s beta is 1.22.
Stockholders require a risk premium of 5 percent above the return on the firms bonds.
The firm expects to have additional retained earnings of $10 million in the coming year, and expects depreciation expenses of $35 million.
Your firm does not use notes payable for long-term financing.
The firm considers its current market value capital structure to be optimal, and wishes to maintain that structure. (Hint: Examine the market value of the firm’s capital structure, rather than its book value.)
The firm is currently using its assets at capacity.
The firm’s management requires a 2 percent adjustment to the cost of capital for risky projects.
Your firm’s federal + state marginal tax rate is 40%.
Your firm’s dividend payout ratio is 50 percent, and net profit margin was 8.89 percent.
PROJECT DELIVERABLES: Steps to WACC for the Optimal Capital Structure
Find the costs (rate of return under current market conditions) of the following individual capital components:
(ITEM #1)-Long-term debt, Bonds. [Hint: PV=-$874.78 (current selling price of Bonds), FV = $1000, PMT=$100, n=15 solve for i]. This is a calculator problem and if you follow the hints you will find the effective rate (see textbook appendix 10B, pages 337: Bond Valuation)
ITEM #2)-New Preferred stock
ITEM #3)-New common stock
(ITEM #4)-Compute the current Total Value of the Firm depicting its long-term elements of the capital structure.
(ITEM #5)-Determine the target percentages for the optimal capital structure: i.e. the weighted average cost of capital (WACC) using current values
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