A
company has a capital structure as follows: Total Assets $600,000 Debt $300,000
Preferred Stock $100,000 Common Equity $200,000.
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File Name: A company has a.xls File type: XLS PRICE: $6
What
would be the minimum expected return from a new capital investment project to
satisfy the suppliers of the capital? Assume the applicable tax rate is 40%,
interest on debt is 11%, flotation cost per share of preferred stock is $0.75,
and flotation cost per share of common stock is $4. The preferred and common
stocks are selling in the market for $26 and $143 a share respectively, and
they are expected to pay a dividend of $2 and $7, respectively, in one year.
The company's dividends are expected to grow at 13% per year. The firm would
like to maintain the existing capital structure to finance the new project.
Answer: The minimum expected return from a new capital investment project is
the WACC plus any additional risk premium. Since no additional risk is
mentioned, we will use the WACC.
Cost of debt = Interest rate x (1 - Tax rate)
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Interest rate =
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11%
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Tax Rate =
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40%
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Cost of debt =
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6.60%
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