5. Family Motors Inc. has the following capital. Debt: The firm issued 1000, 30
ID: 456284 • Letter: 5
Question
5. Family Motors Inc. has the following capital. Debt: The firm issued 1000, 30 year bonds ten years ago which were sold at a par value of $1,000. The bonds carry a coupon rate of 8%, but are currently selling to yield new buyers 12%. Preferred Stock: 4,000 shares of 10% preferred were sold 12 years ago at a par value of $60. They’re now priced to yield 12%. Equity: The firm got started with the sale of 12,000 shares of common stock at $120 per share. Since that time earnings of $800,000 have been retained. The stock is now selling for $100. Family’s business plan for next year projects net income of $300,000, half of which will be retained. The firm’s marginal tax rate is 25% including federal and state obligations. It pays flotation costs of 10% on all new stock issues. Family is expected to grow at a rate of 5% indefinitely and recently paid an annual dividend of $5.00. Develop Family’s WACC before and after the retained earnings break and indicate how much capital will have been raised when the break occurs. First develop the market based capital structure by valuing the capital components:
Debt:
Preferred:
Equity:
The market value based capital structure is then
Total capital contribution Weight
Debt
Preferred Stock
Equity Capital
Total Next
develop the capital component costs.
Debt:Cost of debt = kd(1-T) = __________________________________________________________
Preferred:Cost of preferred = kp / (1-f) = _________________________________________________
Equity from RE: ke = [D0(1+g) / P0] + g = _________________________________________________
Equity from new stock: ke = [D0(1+g) / P0(1-f)] + g = __________________________________________ _____________________________________________________________________________________
WACC calculations:
Before the break
Mix Cost Factor
Debt
Preferred Stock
Equity Capital
Total
After the break
Mix Cost Factor
Debt
Preferred Stock
Equity Capital
Total
Calculate the break point Planned RE =
Explanation / Answer
Preferred: Each preferred share pays a dividend of
$60 x 0.12 = $7.2.
And is valued at
$7.2 / .12 = $60
Equity: Simply multiply the number of shares outstanding by the stock’s market price for the market
value of equity
10,000 x $100.00 = $1000000,000
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