What is the cost for each of the five sources of capital

Reference no: EM132202327

Question - Timel Company is in the process of determining its capital budget for the coming fiscal year. Timel Company's balance sheet reflects five sources of long-term funds. The current outstanding amounts from these five sources are shown below and represent the company's historical sources of funds fairly accurately

Source of Funds	$ Amount (in Millions)	%
Mortgage bonds	135	15
Debenture bonds	225	25
Preferred stock	90	10
Common equity	450	50
Total	900	100

Timel will raise the funds necessary to support the selected capital investment projects so as to maintain its historical distribution among the various sources of long-term funds. Thus, 15% will be obtained from additional mortgage bonds on new plant, 25% from debentures (a generic type of bonds), 10% from preferred stock, and 50% from some common equity source. Timel's policy is to reinvest the funds from each year's earnings in new projects. Timel issues new common stock only after all funds provided from retained earnings have been exhausted. Management estimates that its net income after taxes for the coming year will be $4.50 per common share (for 15 million shares). The dividend payout ratio will be 40% of earnings to common shareholders, the same ratio as the prior 4 years. The earnings retained will be used as needed to support the capital market.

Source of Funds	Par Value ($)	Characteristics	Issue Price ($)
Mortgage bonds	1,000	30 year, 7½%, annual payment	980.00
Debentures	1,000	25 year, 8%, semi-annual payment	1,100.00
Preferred stock	100	7%	99.25
Common stock	10		67.50

The estimated interest rates on the debt instruments and the dividend rate on the preferred stock are based upon the rates being experienced in the market by firms that are of the same size and quality as Timel. The investment banker estimated Timel's annual growth rate to be 10%. In addition, the bank is charging Timel a floatation cost of 7% for its common and preferred equities offering but nothing for its debt offerings. Timel is subject to a 35% income tax rate.

a. What is the cost for each of the five sources of capital (i.e. mortgage bonds, debenture bonds, preferred stock, retained earnings, and common stock) for Timel Company?

b. What is the break point associated with Timel's MCC schedule?

c. What is the average cost of capital for each interval of Timel's MCC schedule?

Reference no: EM132202327

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