QuestionQ1Hammell Industries has been using 10% as its cost of retai

Q1

Hammell Industries has been using 10% as its cost of retained earnings for a number of years. Management has decided to revisit this decision based on recent changes in financial markets. An average stock is currently earning 8%, treasury bills yield 3.5%, and shares of Hammell’s stock are selling for $29.44. The firm just paid a dividend of $1.50, and anticipates growing at 5% for the foreseeable future. Hammell’s CFO recently asked an investment banker about issuing bonds and was told the market was demanding a 6.5% coupon rate on similar issues. Hammell stock has a beta of 1.4. Recommend a cost of retained earnings for Hammell.

Q2

MCC: Example 13-9 (page 573)

. Whitley Motors Inc. has the following capital.

Debt: The firm issued 900, 25 year bonds five years ago which were sold at a par value of $1,000. The bonds carry a coupon rate of 7%, but are currently selling to yield new buyers 10%.

PreferredStock:3,500 shares of 8% preferred were sold 12 years ago at a par value of $50. They’re now priced to yield 11%.

Equity: The firm got started with the sale of 10,000 shares of common stock at $100 per share. Since that time earnings of $800,000 have been retained. The stock is now selling for $89. Whitley’s business plan for next year projects net income of $300,000, half of which will be retained.

The firm’s marginal tax rate is 38% including federal and state obligations. It pays flotation costs of 8% on all new stock issues. Whitely is expected to grow at a rate of 3.5% indefinitely and recently paid an annual dividend of $4.00.

Develop Whitley’s WACC before and after the retained earnings break and indicate how much capital will have been raised when the break occurs.

Q3

The Longenes Company uses a target capital structure when calculating the cost of capital. The target structure and current component costs based on market conditions follow.

Component Mix Cost*

Debt 25% 8%

Preferred Stock 10% 12%

Common Equity 65% 20%

*The costs of debt and preferred stock are already adjusted for taxes and/or flotation costs. The cost of equity is unadjusted.

The firm expects to earn $20 million next year, and plans to invest $18 million in new capital projects. It generally pays dividends equal to 60% of earnings. Flotation costs are 10% for common and preferred stock.

a. What is Longenes’ initial WACC?

b. Where is the retained earnings breakpoint in the MCC? (Round to the nearest $.1M.)

c. What is the new WACC after the break? (Adjust the entire cost of retained earnings for flotation costs.)

d. Longenes can borrow up to $4 million at a net cost of 8% as shown. After that the net cost of debt rises to 12%. What is the new WACC after the increase in the cost of debt?

e. Where is the second break in the MCC? That is, how much total capital has been raised when the second increase in WACC occurs?

f. Sketch Longenes’ MCC.

Q4

Cost of Capital Comprehensive Problem and IOS: Example 13-10 (page 576) and Combining the MCC and the IOS (page 575)

25. Taunton Construction Inc.’s capital situation is described as follows:

Debt: The firm issued 10,000 25-year bonds10 years ago at their par value of $1,000. The bonds carry a coupon rate of 14% and are now selling to yield 10%.

Preferred Stock:30,000 shares of preferred stock were sold six years ago at a par value of $50. The shares pay a dividend of $6 per year. Similar preferred issues are now yielding 9%.

Equity: Taunton was initially financed by selling 2 million shares of common stock at $12. Accumulated retained earnings are now $5 million. The stock is currently selling at $13.25.

Taunton’sTarget Capital Structureis as follows:

Debt 30.0%

Preferred Stock 5.0%

Common Equity 65.0%

100.0%

Other information:

·

Taunton’s marginal tax rate (state and federal) is 40%.

·

Flotation costs average 12% for common and preferred stock.

·

Short-term treasury bills currently yield 7.5%.

·

The market is returning 12.5%.

·

Taunton’s beta is 1.2.

·

The firm is expected to grow at 6% indefinitely.

·

The last annual dividend paid was $1.00 per share.

·

Tauntonexpects to earn $5 million next yea

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