Schwabb Corporation manufactures industrial type sewing machines. Schwabb Corp.
ID: 2653673 • Letter: S
Question
Schwabb Corporation manufactures industrial type sewing machines. Schwabb Corp. received a very large order from a few European countries. In order to be able to supply these countries with its products, Schwabb will have to expand its facilities. Of the required expansion, Schwabb feels it can raise $85 million internally, through retained earnings. The firm's optimum capital structure has been 35% debt, 10% preferred stock and 55% equity. The company will try to maintain this capital structure in financing this expansion plan. Currently Schwabbs's common stock is traded at a price of $30 per share. Last year's dividend was $1.50 per share. The growth rate is 8%. The company's preferred stock is selling at $45 and has been yielding 6% in the current market. Flotation costs have been estimated at 8% of common stock and 3% of preferred stock. Schwabb Corp. has bonds outstanding at 6%, but its investment banker has informed the company that interest rates for bonds of equal risk are currently yielding 5%. Schwabb's tax rate is 40%.
a) Compute the cost of Kd, Kp, Ke, Kn.
b) Calculate the initial weighted average cost of capital.
c) How large a capital budget can the firm support with retained earnings financing?
Explanation / Answer
Answer: Ke=[Dividend/ (Price-flotation cost)]+growth rate
=1.50(1+0.08)=1.62
Net proceeds=30(1-0.08)=27.6
Ke=(1.62/27.6)+0.08=13.87%
Kd=Yield (1-tax rate)
=5%(1-0.40)=3.0%
Kp=6%(1-0.03)=5.82%
Answer:b
Answer:c IT uses retained earnings to meet equity requirement to the extent possible.
Capital structure Weight Cost of capital WACC Common stock 55% 13.87% 7.6285 Preference share 10% 5.82% 0.582 Deb 35% 3% 1.05 9.2605Related Questions
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