Determine the cost of each capital component

Subject: Business    / Finance

Capital Structure and Cost Please answer the following two questions. Be certain to show all work, calculations and formulae used
to obtain your answers. Verbal explanations may also be used to supplement your quantitative analyses.
Answers alone will earn no credit.
1. ABC, Inc. has the following capital structure which it considers to be optimal:
Debt
Preferred stock
Common Equity 25%
15%
60%
100% ABC’s expected net income this year is $34,285.72; its established dividend payout ratio is
30%; its federal-plus-state tax rate is 40%; and investors expect future earnings and dividends to
grow at a constant rate of 9% annually. ABC paid a dividend of $3.60 per share last year, and its
stock currently sells for $54 per share.
ABC can obtain new financial capital in the following ways: Preferred: new preferred stock with a dividend of $11 per share can be sold to the public
at a price of $95 per share, and Debt: new bonds can be sold to the public at an interest (coupon) rate of 12%.
a. Determine the cost of each capital component (show all work); and
b. Calculate the weighted average cost of capital (WACC) (show all work);
ABC has the following investment opportunities which are average-risk projects:
Project
A
B
C
D
E Project Cost ($)
at t = 0
10,000
20,000
10,000
20,000
10,000 Project’s Expected
Rate of Return (%)
17.4
16.0
14.2
13.7
12.0 c. If ABC does not want to issue any new common stock to finance its proposed capital
projects, which of the above five capital projects should ABC accept? (Show all work.) 2. You are an in-house investment analyst investigating two capital projects, A and Z, being
proposed by your firm. Each project costs $10,000, and you have calculated the firm’s WACC as
12%. Your estimates of the expected cash flows of each project are as follows: 2 Time period 0 1 2 3 4 Project A -$10,000 $6,500 $3,000 $3,000 $1,000 Project Z -$10,000 $3,500 $3,500 $3,500 $3,500 a. Calculate the following for each project: (Show all work you used to obtain your
answers. Don’t be afraid to verbally explain your work. Words and numbers often go
well together!) The net present value (NPV), The internal rate of return (IRR), and The payback.
b. If the two projects are independent, which project(s) should be accepted? Show all
work you used to obtain your answer. Don’t be afraid to verbally explain your work.
Words and numbers often go well together!
c. If the two projects are mutually exclusive, which project(s) should be accepted?
Show all work you used to obtain your answer. Words and numbers often go well
together!

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