Saint Leo Manufacturing is going to introduce a new product line and to accompli

Question

Saint Leo Manufacturing is going to introduce a new product line and to accomplish this
it has four projects analyzed in which it wants to invest a total of $100 million. Your job is to
find what it will cost to raise this amount of capital based on the cost of the capital as outlined
below:

PROJECTS
A B C D
INVESTMENT $30,000,000 $20,000,000 $25,000,000 $25,000,000
EXPECTED RETURN 10.00% 14.00% 11.50% 16.00%

The firms capital structure consists of: FMV
CAPITAL PERCENTAGE AMOUNT
DEBT 30% $15,000,000
PREFERRED STOCK 10% $5,000,000
COMMON STOCK 60% $30,000,000
$50,000,000
Other information about the firm:
CORPORATE TAX RATE 35%
DEBT
CURRENT PRICE $900.00
ANNUAL INTEREST 9.00% CURRENT INTERST PAID SEMIANNUALLY
ORIGINAL MATURITY 25 YEARS, BUT NOW 20 YEARS LEFT
MATURITY VALUE $1,000.00
FLOTATION COST INSIGNIFICANT
MARKET YIELD PROJECTED:
UP TO $20 MILLION 9%
ABOVE $20 MILLION 12% 3 % additional premium

PREFERRED
CURRENT PRICE $50.00
LAST DIVIDEND (D0) $5.00 FIXED AT 10% OF PAR
FLOTATION COST $2.00
NEXT DIVIDEND (D1) $5.00

COMMON
CURRENT PRICE $33.00
LAST DIVIDEND (D0) $1.50
RETAINED EARNINGS $16,000,000
GROWTH RATE (g) 9%
FLOTATION COST $3.00
NEXT DIVIDEND (D1) $1.635

NOTE - Once retained earnings is maxed out, new common stock will need to be issued.
Any preferred stock would be new preferred stock. You may want to review the case in chapter 11.

REQUIRED:
In all of the required parts, one part builds on the previous part. If you can't do a part, use the
set of other numbers to solve the next part.
a. What is the current Kd, Kp, and Ke assuming no new debt or stock is issued?
b. Since any new capital investment will require issuing new preferred stock, what would the
the new returns be for the preferred stock (knp) and the new cost of capital?
c. What is the amount of increase (marginal cost of capital) in capital structure (in $) where the firm runs
out of retained earnings and would be forced to issue new common stock?
d. If new common stock has to be issued, what is the new return required to be (Kne) and the
new cost of capital?

Part a
Current price of the debt (Answer should be in $)
Maturity value of the debt (Answer should be in $)
Interest payment on the debt (Answer should be in $)
Payment periods left on the debt
Yield rate on the debt (Answer should be in %; 2 decimal places, please)
Annual yield on the debt (Answer should be in %; 2 decimal places, please)
Kd (Answer should be in %; 2 decimal places, please)
Kp (Answer should be in %; 2 decimal places, please)
Ke (Answer should be in %; 2 decimal places, please)
Current Cost of Capital (Answer should be in %; 2 decimal places, please)




Part b
Use your solutions in part a to do this part, but if you couldn't complete part a, assume Kd=7%, Kp=11%, and Ke=14%.
Knp preferred stock (Answer should be in %; 2 decimal places, please)
New cost of capital (Answer should be in %; 2 decimal places, please)


Part c
If the capital structure increases more than (Answer should be in $-hint: in millions of dollars)




Part d
Kne common stock (Answer should be in %; 2 decimal places, please)
If you could not come up with the Kne returns, do the cost of capital assuming Kd=7%, Knp=12%, and Ke=14%.
New cost of capital (Answer should be in %; 2 decimal places, please)

Explanation / Answer

Part a 80 Current price $ 900.00 81 Maturity value $ 1,000.00 82 Interest payment $ 45.00 83 Payment periods 40 84 Yield rate 5.090% 85 Annual yield 10.18% 86 Kd 6.62% 87 Kp 10.00% 88 Ke 13.95% 89 Current Cost of capital 11.36% 90 91 92 93 94 Part b 95 Use your solutions in part a to do this part, but if you couldn't complete part a assume Kd=7%, Kp=11%, and Ke=14%. 96 Knp preferred stock 10.42% 97 New cost of capital 11.40% 98 99 100 Part c 101 If the capital structure increases more than $ 26,666,667 102 103 104 105 106 Part d 107 Kne common stock 14.45% 108 If you could not come up with the Kne returns do the cost of captial assuming Kd=7%, Knp=12%, and Ke=14%. 109 New cost of capital 12.33% This will consider increased cost of debt in part F

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