Case Study-Eco Plastics Company
Eco Plastics Company
Since its inception, Eco Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Eco’s founder, Marion Cosby, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for six years, Eco went public in 2009 and is listed on the Nasdaq stock exchange.
As the chief financial officer of a young company with lots of investment opportunities, Eco’s CFO closely monitors the firm’s cost of capital. The CFO keeps tabs on each of the individual costs of Eco’s three main financing sources: long-term debt, preferred stock, and common stock. The target capital structure for ECO is given by the weights in the following table:
Source of capital Weight
Long-term debt ……………… 30%
Preferred stock ………………… 20
Common stock equity ………….. 50
Total …………………………. 100%
At the present time, Eco can raise debt by selling 20-year bonds with a $1,000 par value and a 10.5% annual coupon interest rate. Eco’s corporate tax rate is 40%, and its bonds generally require an average discount of $45 per bond and flotation costs of $32 per bond when being sold. Eco’s outstanding preferred stock pays a 9% dividend and has a $95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Eco is a young firm that requires lots of cash to grow it does not currently pay a dividend to common stock holders. To track the cost of common stock the CFO uses the capital asset pricing model (CAPM). The CFO and the firm’s investment advisors believe that the appropriate risk-free rate is 4% and that the market’s expected return equals 13%. Using data from 2009 through 2012, Eco’s CFO estimates the firm’s beta to be 1.3.
Although Eco’s current target capital structure includes 20% preferred stock, the company is considering using debt financing to retire the outstanding
Since its inception, Eco Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Eco’s founder, Marion Cosby, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for six years, Eco went public in 2009 and is listed on the Nasdaq stock exchange.
As the chief financial officer of a young company with lots of investment opportunities, Eco’s CFO closely monitors the firm’s cost of capital. The CFO keeps tabs on each of the individual costs of Eco’s three main financing sources: long-term debt, preferred stock, and common stock. The target capital structure for ECO is given by the weights in the following table:
Source of capital Weight
Long-term debt ……………… 30%
Preferred stock ………………… 20
Common stock equity ………….. 50
Total …………………………. 100%
At the present time, Eco can raise debt by selling 20-year bonds with a $1,000 par value and a 10.5% annual coupon interest rate. Eco’s corporate tax rate is 40%, and its bonds generally require an average discount of $45 per bond and flotation costs of $32 per bond when being sold. Eco’s outstanding preferred stock pays a 9% dividend and has a $95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Eco is a young firm that requires lots of cash to grow it does not currently pay a dividend to common stock holders. To track the cost of common stock the CFO uses the capital asset pricing model (CAPM). The CFO and the firm’s investment advisors believe that the appropriate risk-free rate is 4% and that the market’s expected return equals 13%. Using data from 2009 through 2012, Eco’s CFO estimates the firm’s beta to be 1.3.
Although Eco’s current target capital structure includes 20% preferred stock, the company is considering using debt financing to retire the outstanding