Solutions Guide: Please reword the answers to essay type parts so as to guarantee that your answer is an original.

Do not submit as your own. Star Products Company: discuss sources of financing, break even, WACC Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter !"C# market$ %uring &''(, the %allas- based company e)perienced sharp increases in both sales and earnings$ *ecause of this recent growth, +elissa ,en, the company-s treasurer, wants to make sure that available funds are being used to their fullest$ +anagement policy is to maintain the current capital structure proportions of .'/ long-term debt, 0'/ preferred stock, and 1'/ common stock e2uity for at least the ne)t . years$ "he firm is in the 3'/ ta) bracket$ Stars division and product managers have presented several competing investment opportunities to ,en$ 4owever, because funds are limited, choices of which pro5ects to accept must be made$ "he investment opportunities schedule 6!S# is as follows: 6nvestment !pportunities Schedule 6!S# for Star Products Company 6nvestment 6nternal rate of 6nitial opportunity return 677# investment A 08/ 9 3'',''' * && &'',''' C &8 :'',''' % &. 3'',''' ; 0: 8'',''' < 0( 1'',''' = 03 8'',''' "o estimate the firms weighted average cost of capital WACC#, ,en contacted a leading investment banking firm, which provided the financing cost data shown in the following table$ <inancing Cost %ata Star Products Company Star Products Company >ong- term debt: "he firm can raise 9 38',''' of additional debt by selling 08-year, 90,'''- par- value, (/ coupon interest rate bonds that pay annual interest$ 6t e)pects to net 9 (1' per bond after flotation costs$ Any debt in e)cess of 938',''' will have a before- ta) cost, rd, of 0./$ Preferred stock: Preferred stock, regardless of the amount sold, can be issued with a 9:' par value and a 03/ annual dividend rate and will net 918 per share after flotation costs$ Common stock e2uity: "he firm e)pects dividends and earnings per share to be 9'$(1 and 9.$&', respectively, in &'0' and to continue to grow at a constant rate of 00/ per year$ "he firms stock currently sells for 90& per share$ Star e)pects to have 90,8'',''' of retained earnings available in the coming year$ !nce the retained earnings have been e)hausted, the firm can raise additional funds by selling new common stock, netting 9( per share after underpricing and flotation costs$ "o %o: a$ Calculate the cost of each source of financing, as specified: 0# >ong- term debt, first 938','''$ &# >ong- term debt, greater than 938','''$ .# Preferred stock, all amounts$ 3# Common stock e2uity, first 90,8'','''$ 8# Common stock e2uity, greater than 90,8'','''$ b$ <ind the break points associated with each source of capital, and use them to specify each of the ranges of total new financing over which the firms weighted average cost of capital WACC# remains constant$ c$ Calculate the weighted average cost of capital WACC# over each of the ranges of total new financing specified in part b$ a. Cost of financing sources Debt:

*elow 938',''':

kd =

6+

90,''' ?d # n ?d + 90,'''# &

90,''' 9(1'# 08 9(1' + 90,'''# &

kd =

9(' +

kd =

9(&$1: = $'(31 = ($31/ 9(@'

ki A kd ) 0 - t# ki A ($31 ) 0 - $3# ki A 8$1@/ Above 938',''': ki A kd ) 0 - t# ki A 0.$' ) 0 - $3# ki A :$@/

Preferred Stock:
kp = %p ?p 9($@' = $08'@ = 08$'@/ 918

kp =

Common Stock Equity: 9' - 90,8'',''': kr A %i P'# B g kr A 9$(1 90&# B $00 kr A $0( or 0(/ Above 90,8'',''': kn A %i ?n# B g A 9$(1 9(# B $00 A $&011 or &0$:/
A<5 Wi 938',''' = 90,8'',''' $.'

b.

Breaking points *reaking point A *P>ong-term debt A

*Pcommon e2uity c.

90,8'',''' = 9&,8'',''' $1'

Weig ted a!erage cost of capital: "arget Capital "#$ "ype of Capital Structure <rom 9' to 90,8'',''': >ong-term debt $.' Preferred stock $0' Common stock e2uity $1' 0$'' Cost of Capital Source 8$:/ 08$0/ 0($'/ WACC Weighted Cost 0$:0/ 0$80/ 00$3'/ 03$1&/ &$.3/ 0$80/ 00$3'/ 08$&8/ &$.3/ 0$80/ 0.$'&/ 01$@:/

"%$ <rom 90,8'',''' to 9&,8'',''': >ong-term debt $.' :$@/ Preferred stock $0' 08$0/ Common stock e2uity $1' 0($'/ 0$'' WACC "&$ Above 9&,8'',''': >ong-term debt Preferred stock Common stock e2uity $.' $0' $1' 0$'' :$@/ 08$0/ &0$:/ WACC