1. Newington Chemicals has planned capital expenditures of $1,600,000 for the co

Question

1. Newington Chemicals has planned capital expenditures of $1,600,000 for the coming fiscal year. The $1,600,000 is to be financed in the following way Debt Preferred Stock Common Equity $400,000 400,000 800,000 The bonds have a coupon rate of 996 and will sell for par value. The preferred stock is 10%, $100 par. It sells for par value with $5 per share flotation costs. The common stock of the company sells for $50 per share with flotation costs of $5.00 per share. It is expected to pay a $3 dividend in the coming year, up 9% from this year. The company's earnings, dividends, and stock price are expected to grow at about 9% indefinitely. The company's tax rate is 40%. The Net Income for the Company this year is $1,300,000. The dividend payout ratio is 60%. Assume the beginning retained earnings balance ALL FORMULAS expected be a) How will the common equity funds of $800,000 be financed- how much of the $800,000 will come from R/E vs. CIS? 1) $ amount from Retained Earnings 2) $ amount from Common Stock b) Calculate the breakpoint for common equity c) Calculate the cost of capital for each of the components

Explanation / Answer

A .No. of equity shares = $800,000/$(50+5) =14,545 shares amount from common Equity (Face Value + Share Premium received) = 14525 x $50 = $726,250 Balance fron retained earning = $73,750

1.Amount from retained earnings=$73,750.

2.Amount from common stock=$726,250.

B.

Step 1-Calculation of Weight of common equity

=$800,000/$1600,000=50%

Step-2-calculation of Break point

= (amount of equity at which the compnents’s cost of equity changes) /(weight of the equity)

=$800,000/.50=$16,00,000

C.Cost of capital each of the component.

1.Debt=Interest rate *(1-tax rate) = 9%*1-40% =5.4%

2.Prefered Stock=Preference stock dividend / market price*(1-flotation cost)

=$10 / $100 * (1-5%) = 10.53%

3.Retained Stock=The cost of retained earnings is the earnings foregone by the shareholders=14.45%

4.Common stock= Dividend / issue price + Growth

=3 / 55 + 9%=14.45%

  

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