Nealon Energy Corp. constructing a natural gas gathering center estimated cost o

Question

Nealon Energy Corp. constructing a natural gas gathering center estimated cost of $70 million. To finance, Nealon has $20 million in profits to finance a portion of teh expansion and plans to sell a bond issue to raise the remaining $50 million.The following balance sheet reflects the mix of capital sources that Nealon has used in the past.

Source of Financing            Target Capital Structure Weights

Bonds                                40%

Common Stock                   60%

The firm currently has one issue of bonds coutstanding. The bonds have a par value of $1000 per bond, carry an 8% coupoun rate of interest, 16 years to maturity, and sellin for $1,035. Common stock current market price of $35 and paid a $2.50 dividned lasy year that is expected to increase at an annual rate of 6%.

a. What is the yield to maturity for Nealon's bonds under current market conditions?

b. Waht is the cost of new debt financing to Nealon based on current market prices after both taxes (34% marginal tax rate) and floatation costs of $30 per bond?

c. What is the investor's required rate of return for Nelaon's common stock? If Nealon were to sell new shares of common stock it would incur a cost of $2.00per share. What is your estimate of the cost of new equity financing raised from the sale of common stock?

d. Compute the weighted average cost of capital for Nealon's investment unsing the weighs reflected in the actual financing mix (that is $20 mil in retained earnings and $50 mil in bonds).

e. Compute the weughted average cost of capital for Nealon where the firm maintains its target capital structure by reducing debt offering to 40% of teh $70 mil in new capital, or $28 mil using $20 mil in retained earnings and raisng $22 mil througha new equity offering

f. If you were the CFO for the company, would you prefer to use the calculation cost of capital in part (d) or (e) to evaluate the new project? Why?

Explanation / Answer

Hey please dont do this ... I have done a lot of hardwork to solve this question... please atleast give a 3 star... I bet nobody else would give a more detailed answer.. please be human ..

a) yeild to maturity = r ...

so ... 0 = -1035 + 80* PVAF ( 16 years , r% ) + 1000* PVF ( 16 years , r % )

on solving we get ... r = 7.61 %

so yoeld to maturity = 7.61 %

b)

no. of bonds issured = 50,000,000 / 1000 = 50,000 bonds..

so floatation cost = 50,000 * 30 = 1,500,000

every year interest = 80 * 50,000*(1-0.34 ) = 2640000

so the cash flows for the company are :

year 0 : 50,000,000 - 1,500,000 = 48500000

year 1: -2640000

year 2 : -2640000

.

.

.

year 15 : -2640000

year 16 : -50,000,000 - 2640000

so computing the IRR for the abve cash flows we get..

rate = 5.57 %

cost of new debt = 5.57 %

c)

expected return = [dividend * ( 1 + growth rate ) / ( market price ) ] + growth rate

so exprect rate of return = [ 2.5 * ( 1 + 0.06 ) / 35 ] + 0.06 = 13.57 %

cost of equity for company = 2.5 * ( 1 + 0.06 ) / ( 35 -2 ) + 0.06 = 14.03 %

d) WACC = (50 / 70 ) * 5.57 % = 3.97857 %

e) WACC = (0.4 * 5.57 ) + ((22/70) *14.03) = 6.637 %

f) I would use tehh calculation in part (d) ... as it has lower cost associated and also the firm's aim is to maximize the shareholders wealth

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.