Bus401 Mini Case Chapter 9

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Percentage of future financing
Type of financing

Bonds (8%, $1,000 par, 16- year maturity38%

Preferred stock (5,000 shares outstanding
$50 par, $1.50 dividend15%

Common equity47%

Total100%

A. Market prices are $1,035 for bonds, $19 for preferred stock, and $35 for common stock. There will be sufficient internal common equity funding (i.e., retained earnings) available such that the firm does not plan to issue new common stock. Calculate the firm's weighted average cost of capital.

BondsPreferred stockCommon Stock
1035-15% (155.25) = 879.75 1.50/(19-2.01) 16.99 = 8.83% 2.65/35 + .06 = 13.57% 9.49%

9.49% (1-.34) = 6.26%

WeightsAfter tax captialProduct

Bond 0.38X6.26%=2.3788
Preferred Stock0.15X8.83%=1.3245
Common Stock0.47X13.57%=6.3779
10.08%

B. In part a we assumed that Nealon would have sufficient retained earnings such that it would not need to sell additional common stock to finance its new investments. Consider the situation now when Nealon's retained earnings anticipated for the coming year are expected to fall short of the equity requirement of 47% of new capital raised. Consequently, the firm foresees the possibility that new common shares will have to be issued. To facilitate the sale of shares, Nealon's investment banker has advised management that they should expect a price discount of approximately 7%, or $2.45 per share. Under these terms, the new shares should...
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