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Question - Saven Travel Corporation is considering several investment opportunities in order to diversify its operations. Mr. Saven, president, is trying to determine the firm's cost of capital before he makes a decision. This diversification plan will require the firm to have access to $400 million. The first $250 million will come from their current capital structure. The firm has $150 million already from common equity (common stock and retained earnings). And $100 million in bonds yielding 12%. The company's tax rate is 46%.
A share of common stock is currently selling for $50, and the amount of the last dividend paid was $1.25. The company's earnings and dividends have been growing at about 12%, however, this is expected to drop to 9% per year in the future. Flotation costs of new common will be $4.00 per share.
Required -
A) Compute the weighted average cost of capital on the first $250 million of funds.
B) Keeping the same weights, Saven Travel will need to raise $150 of additional capital for expansion. How much of this will be debt? How much will be equity?
C) Compute the marginal cost of capital on the additional $150 million assuming the cost of debt stays the same.
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