12-12 The White Corporation makes small Bozo replicas for sale in the growing Au
ID: 2775215 • Letter: 1
Question
12-12 The White Corporation makes small Bozo replicas for sale in the growing Austin market. The firm's capital structure consists of 60 percent common equity, 10 percent preferred stock, and 30 percent long-term debt. This capital structure is believed to be optimal. White is planning to raise funds over the coming year to finance expansion plans. The firm expects to have $40 million of retained earnings available. The cost of retained earnings is 18 percent. Additional common equity can be obtained by selling new common stock at a cost of 19.6 percent. The firm can sell a maximum amount of $20 million of preferred stock at a cost of 15 percent. First-mortgage bonds totaling $25 million can be sold at a pretax cost of 14 percent. Beyond $25 million, the firm would have to sell debentures at a pretax cost of 15 percent. The firm's marginal tax rate is 40 percent. Identify the size of each block of funds and the cost of the funds in each block. Be sure to identify the maximum amount of funds White can acquire.Explanation / Answer
preferred stock given maximum $20 it means it is itself 10%
so 100% is $200 million.
Size of each block of fund
Equity and retained eranings = 200*60% = $80 million $ $ 40 million
preferred stock =$20million
Long term debt = $60 million
Cost of funds
equtiy = (19.6%* 80/200) => 7.84%
retained earnings = (18%*40/200) => 3.6%
preferred stock = (15%*20/200) => 1.5%
long term debt upto 25 million = (14%(1-40%) * 25/200) => 1.05%
long term debt beyond 25 million = (15%(1-40%) * 35/200) => 1.575%
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