Management has concluded that capital structure is optimal

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Reference no: EM131610697

Jarvey Inc. has a debt ratio of 25 percent. Management has concluded that this capital structure is optimal. Jarvey has analysed its investment opportunities for the coming year and has identified 4 possible additions to assets which generate IRRs greater than zero.

Investment Size IRR

A $ 6 million 16.2%

B 12 million 15.3%

C 12 million 14.1%

D 6 million 13.0%

Jarvey is forecasting net income for the coming year of $15 million and expects to pay out 40.00 percent in dividends to the 1 million outstanding shares of common stock. Earnings have been growing at a constant rate of 8.00 percent over the past few years, and this rate is expected to continue indefinitely. If Jarvey has to sell new common stock, it will be faced with flotation costs of 15.00 percent (current market price = $75 per share). Jarvey uses no preferred stock in its capital structure, and any debt that is raised at par, up to $7.50 million, will require a coupon rate of 8.00 percent. However, if the total debt required is greater than $7.50 million, the coupon rate will have to be 10.00 percent. The marginal tax rate is 40.00 percent. How large will the capital budget be if all investments with IRR > MCC are accepted? (Note: Your answer should include a graph showing the MCC and investment opportunity schedules for Jarvey Inc.)

Reference no: EM131610697

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