Reference no: EM131466531

You are given the following information about a company. Their tax rate is 34%. The firm is in need of $5 million dollars in external funds. Your bond advisor suggests that new bond issues can be lower than the current yield to maturity by 2.0% . You are not sure he is correct. Should you issue the new debt to raise money?

Existing capital structure:

Debt: 5,000 Eight percent (8%) coupon bonds outstanding. The par value is $1000 and they mature in ten years. They are currently selling for $1250 and make semiannual payments.

Equity: 50,000 shares outstanding. The common stock is currently selling for $72 per share. The beta for the company is 1.15.
Preferred Stock: 10,000 shares of 2% preferred stock with a par value of $100, and is currently selling for $65 per share.

Market Information: The risk of the market is 6% and the risk-free rate is 2%. The industry debt-equity ratio is 33%.

The flotation rate for new debt is 3% and for new equity it is 5%.

1. Calculate the existing weighted average cost of capital.

2. New cost of capital if add 5M in new bonds

This assumes we sell enough bonds to realize 5M. Since the price will be net of flotation we need to sell them at 1000 but net a bit less.

3. What if they finance the 5M with all equity? What would the capital structure and WACC look like?

4. What if they add 5M in financing split among debt and equity in proportions equal to the current capital structure. What is the WACC?