Reference no: EM132767118

Questions - From the topic of Cost Capital, Financial Leverage and Capital Structure

Problem 1 - Company Z has a bond issue outstanding that matures in fourteen years. The bonds pay interest semiannually. Currently, the bonds are quoted at 98 percent of face value and carry an 8 percent coupon. The firm's tax rate is 35 percent. What is the firm's after-tax cost of debt?

Problem 2 - Medallion Cooling Systems, Inc., has total assets of P10,000,000, EBIT of P2,000,000, and preferred dividends of P200,000 and is taxed at a rate of 30%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

Capital structure debt ratio Cost of debt, rd Number of common stock shares Required return, rs

0% 0% 200,000 12%

15% 8 170,000 13

30% 9 140,000 14

45% 12 110,000 16

60% 15 90,000 20

Choose the optimal capital structure. Justify your choice

Problem 3 - X Company wants to raise P20,000,000 to expand its portfolio of second mortgages and substandard auto loans. Bank financing agreements limit X Company to a maximum of 75% debt. They can borrow money at 14%, and they are in the 35% tax bracket. New retained earnings are P200,000. X Company can privately place P1,000,000 of preferred stock at 12%, and preferred floatation costs are 8.0%. Their current stock price is P20; dividends are P0.85, and have been growing at 11% per year; and flotation costs are P5 per share.

Compute the weighted average cost of capital considering the following strategy.

a. What is the weighted average cost of new capital using only new retained earnings (30%) and debt (70%)?

b. What is the weighted average cost of new capital from the preferred stock offering with a blend of 25% preferred and 75% debt?

c. What is the weighted average cost of new capital maintaining a mix of 25% newly issued common stock and 75% debt?