Case Study

(a)
1.
rd=[I +($1,000-Nd)/n]/(Nd+$1000)/2
I=1000*0.09=$90
Nd=$960
n=15
rd=9.5%

after tax cost=before tax cost * (1-T)=9.5*(1-0.4)=5.7%

2
ri=rdX(1-T)=13*(1-0.4)=7.8%
3
rp=Dp/Np
Dp= 70*0.14=$9.8
Np=65
rp=9.8/65=15.07%
4
rs=D1/P0+g
D1=0.96
P0=12
g=11%

rs=0.96/12+0.11= 19%
5
rs=D1/P0+g
D1=0.96
P0=9
g=11%
rs=0.96/9+0.11=21.67%

(b)
Breakpoint for debt =Bp=AF/wj= 450,000/0.3=1,500,000
The range is 0-1,500,000 and then 1,500,000 onwards
Breakpoint for equity=1,500,000/0.6=2,500,000
The range is 0 to 2,500,000 and then 2,500,000 onwards
c)
$0 - $1,500,000

Source of capital
Debt
Preferred Stock
Common Stock
WACC

Weight
30%
10%
60%

Cost
5.7
15.07
19

WACC
1.71
1.51
11.4
14.62

Weight

Cost

WACC

1,500,000 to 2,500,000

Source of capital

Debt
Preferred Stock
Common Stock
WACC

30%
10%
60%

7.8
15.07
19

2.34
1.51
11.4
15.25

Weight
30%
10%
60%

Cost
7.8
15.07
21.67

WACC
2.34
1.51
13
16.85

WMCC
14.62%
15.25%

IRR
25
23

2,500,000 and above

Source of capital
Debt
Preferred Stock
Common Stock
WACC

(d)

Total new finacing

$0-$1,500,000
$1,500,000-$2,500,000

Cumulative Investment
inv
opportunity
700,000
A
1,100,000
B

$2,500,000 and above

16.65%

22
19
17
15
14

1,300,000
1,900,000
2,400,000
2,800,000
3,300,000

C
D
E
F
G

red- accetable projects

blue- unaccetable projects

30.00%

25.00%

20.00%

WMC
C
IRR

15.00%

10.00%

5.00%

0.00%
$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

e)
Company should accept projects up to the point at which the marginal rate
of return on an investment equals its weighted marginal cost of capital.
In our situation optimal capital budget is $ 2,400,000 and at that point IRR
equals the weighted average cost of capital=15.25% and therefore
Project A,B,C,D,E (marked in red) are acceptable. Project F is not acceptable
because its 15% return is less than 15.25% weighted average cost. Project G
is also not acceptable because 14% return is less than 15.25
weighted average cost