MGT 325 Module 5 Spreadsheet Exam - this is one long problem or case study. Plea
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Question
MGT 325 Module 5 Spreadsheet Exam - this is one long problem or case study. Please show all of your work.Please place your answers to each question in each part in the outlined boxes in the yellow spaces at the bottom of the worksheet.
To do this exam you need to study the cases at the end of Chapter Eleven. Remember that the cost of debt
when calculated is before tax and has to be converted to an after tax return. The returns on preferred and
common stock are already after tax so are not adjusted, which is explained in Chapter ten.
PROBLEM FOR CHAPTERS TEN AND ELEVEN
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?
Explanation / Answer
Part a Current price $900.00 Maturity value $(1,000.00) Interest payment $(45.00) Payment periods 40 Yield rate 5.090% six month rate Annual yield 10.18% annual rate Kd 6.62% Kp 10.00% D1/Price Ke 13.95% (D0*(1+g))/(Price)+g or D1/(Price)+g Current Cost of capital 11.36% (30%*Kd)+(10%*Kp)+(60%*Ke) Can't really use the current cost of capital since accepting any new projects will require issuing new Preferred stock requiring a rate higher than its current 10% yield. 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 10.42% D1/(Price-Floatation) New cost of capital 11.40% (30%*Kd)+(10%*Knp)+(60%*Ke) Part c If the capital structure increases more than $26,666,667 New common stock will have to be issued to finance new projects since internally generated RE runs out, and the required return on common stock will increase as demanded by shareholders. Part d Kne common stock 14.45% (D0*(1+g))/(Price-Floatation)+ g or D1/(Price-Floatation)+g If you could not come up with the Kne returns do the cost of captial assuming Kd=7%, Knp=12%, and Ke=14%. New cost of capital 11.70% (30%*Kd)+(10%*Knp)+(60%*Kne)
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