04 Jun IF THE COEFFICIENT OF VARIATION INDICATES THAT THIS IS A HIGH RISK PROJECT AND IF HIGH RISK PROJECTS SHOULD HAVE 2.5%
Question
Office Supplies
Fairfield
Office Supplies Inc. has a regional chain of office supply stores in the
Midwest. Fairfield is trying to compete
with the large nationwide office supply companies. It is January of 2013 and Fairfield needs to
make some capital budgeting decisions this year. They need to decide whether to replace their
computerized inventory system or upgrade the old one, whether to purchase two
stores from a sole proprietor or not, whether to keep, abandon or modernize one
of the stores, which new copiers to purchases and a few other small
projects. The company is under some
pressure and has a strict capital budget of $11million,
so they need to be careful as to which projects they choose.
Examine
the following book-value balance sheet for Fairfield Office supplies for the
year 2012. What is the capital structure
of the firm based on market values?
The preferred stock currently sells for $5.75 per share and the common
stock for $17.00 per share. The preferred stock pays a dividend of $.65 per
share, the Common Stock paid a dividend of $1.10 last year, and the firm is
expected to continue to grow at the same rate as the net income for the past
five years, The rate on 90 day treasuries is 1.90%, the beta of the stock is 1.5,
the market risk premium is 8%, and the firm’s tax rate is 40%. The float costs are as follows: Debt: 10% of
par, preferred: $0.5 per share and Common: $2.00 per share. The firm has paid out 25% of its net income
as dividend in the past five years and is expected to continue. If the company borrows over $1.0 million then
the cost of debt goes from 10.0% to 12.5% (including flotation) and if the
company borrows over $2 million the cost goes to 14% (including flotation). Find
the Marginal costs of capital for Fairfield. Fairfield tax rate is 40%. (For
Required return of retained earnings use an average of the DCF method and the
CAPM method).
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