Reference no: EM132739985

Ricon Raquets is considering taking on additional debt to fuel its growth. But before that decision is made, the chief financial officer wants the latest estimate of the company's cost of capital and asks you to calculate it. You know the following information about Ricon's securities and the market:

Bonds Common Stock
3000 bonds outstanding 200,000 shares outstanding
$1000 par value Expected dividend in 2020 = $3.24
8.5% coupon rate Market price = $36
7 years to maturity
Market price = $1047

Ricon's marginal tax rate = 30% risk-free rate = 4%
Ricon's expected growth rate = 3% average market return = 9%
Ricon's beta = 1.4

Problem a. Estimate Ricon's component cost of debt.

Problem b. Estimate Ricon's component cost of equity using as many methods as possible. Which estimate you will use?

Problem c. Estimate Ricon's weighted average cost of capital. The amount of additional debt Ricon is considering would change its capital structure to a mix of 60% debt and 40% equity.

Problem d. Estimate what Ricon's cost of capital would be after the new debt is issued assuming that the component costs of debt and equity found in (b) and (c) stay the same.

Problem e. Explain why it is highly unlikely that the component costs of debt and equity would stay the same if new debt is issued and the capital structure mix changes.

Problem f. The CFO asks for your general thoughts about taking on more debt. Aside from the cost of capital calculation, what other qualitative factors do you think Ricon must consider in making its decision?