Saint Leo Manufacturing is going to introduce a new product line and to accompli
ID: 2699282 • Letter: S
Question
Saint Leo Manufacturing is going to introduce a new product line and to accomplish thisit 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 and based on the cost of capital determine which of the
projects should be accepted by the firm to invest in.
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 40% $20,000,000
PREFERRED STOCK 15% $7,500,000
COMMON STOCK 45% $22,500,000
$50,000,000
Other information about the firm:
CORPORATE TAX RATE 35%
DEBT
CURRENT PRICE $1,075.00
ANNUAL INTEREST 6.00% CURRENT INTEREST 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 $35.00
LAST DIVIDEND (D0) $2.63 FIXED AT 7.5% OF PAR
FLOTATION COST $1.00
NEXT DIVIDEND (D1) $2.63
COMMON
CURRENT PRICE $25.00
LAST DIVIDEND (D0) $1.00
RETAINED EARNINGS $10,000,000
GROWTH RATE (g) 9%
FLOTATION COST $1.50
NEXT DIVIDEND (D1) $1.090
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 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?
b. Since any new capital investment will require issuing new perferred stock, what would the
the new returns be preferred stock (knp) and the new cost of capital?
c. What amount of increase (marginal cost of capital) in capital structure will the firm run
out of retained earnings and be forced to issue new common stock?
d. If new common stock has to be issued what will the new return required be (Kne) and the
new cost of capital?
Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.
Part a
Current price $1,075.00
Maturity value $1,000.00
Interest payment $32.25
Payment periods 40
Yield rate %
Annual yield %
Kd %
Kp %
Ke %
Current Cost of capital %
Part b
Use your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%; =
% Knp preferred stock %
New cost of capital %
Part c
If the capital structure increases more than
$
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 %
If you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%=
% New cost of capital
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 and based on the cost of capital determine which of the
projects should be accepted by the firm to invest in.
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 40% $20,000,000
PREFERRED STOCK 15% $7,500,000
COMMON STOCK 45% $22,500,000
$50,000,000
Other information about the firm:
CORPORATE TAX RATE 35%
DEBT
CURRENT PRICE $1,075.00
ANNUAL INTEREST 6.00% CURRENT INTEREST 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 $35.00
LAST DIVIDEND (D0) $2.63 FIXED AT 7.5% OF PAR
FLOTATION COST $1.00
NEXT DIVIDEND (D1) $2.63
COMMON
CURRENT PRICE $25.00
LAST DIVIDEND (D0) $1.00
RETAINED EARNINGS $10,000,000
GROWTH RATE (g) 9%
FLOTATION COST $1.50
NEXT DIVIDEND (D1) $1.090
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 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?
b. Since any new capital investment will require issuing new perferred stock, what would the
the new returns be preferred stock (knp) and the new cost of capital?
c. What amount of increase (marginal cost of capital) in capital structure will the firm run
out of retained earnings and be forced to issue new common stock?
d. If new common stock has to be issued what will the new return required be (Kne) and the
new cost of capital?
Note: All Answers Should Be Taken Out to 2 Decimal Places, Especially the Interest Rate Answers.
Part a
Current price $1,075.00
Maturity value $1,000.00
Interest payment $32.25
Payment periods 40
Yield rate %
Annual yield %
Kd %
Kp %
Ke %
Current Cost of capital %
Part b
Use your solutions in Part a to do this part, but if you couldn't complete Part a, assume Kd=4%, Kp=8%, and Ke=13%; =
% Knp preferred stock %
New cost of capital %
Part c
If the capital structure increases more than
$
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 %
If you could not come up with the Kne common stock returns, do the cost of capital assuming Kd=5%, Knp=9%, and Ke=14%=
% New cost of capital
Explanation / Answer
9. Yes, particularly given her initial success on QVC. Pairing this exposure with an on-line site can help the business grow inexpensively. Also noting the website on all product packaging can help her in her drive to promote new products she plans to add.
Yes, Laura should consider about it and for this she should use the following way to drive the customers to the website:
1. Develop good headlines.
2. Write quality articles rich in content
3. Address a specific audience
4. Content should be easily share able.
10. Muslin bags are environmental friendly. It can be re-use repeatedly. It do not pollute the environment. Muslin cloths are made of natural cottons. That is why if muslin bags are use for packaging then it is fantastic idea but this may be costly because of material reasons, labouring etc. This is an added expense and may be more important for tourist gift shops than for supermarket shelves. Cost-conscious consumers don't want to pay for extra packaging. If the bag is not reusable. Reducing the price however, may change the perception of the product as a good value. Research may be needed to compare consumer perceptions of several price point combinations and package sizes. The strategy is to get consumers to try the product so you should maintain the size. Single serve or smaller packaging may be an attractive add-on in the future as could larger sizes. Focus groups and customer surveys can help her determine the best size and mix of packaging.
11. The force-out strategy offers a captive audience from the beginning without having to sell the product to a store manager, however with the challenges with stocking the product, placing it in the correct location, and managing the displays and marketing.
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