Question

need help on question 2. please show work

Shrieves Company has been in the market for many years. Recently the company has decided to look seriously at a 5-year program and raise additional $15 million capital. Assume that you are the CFO of this company, and you need to decide the capital budgeting and evaluate the new program First, the company need estimate the optimal capital structure to minimize the total cost of raising new capital of the company. For long-term capital investment decisions, the company should consider three types of capital used to pay for long-term assets, which are typically long- term debt, preferred stock (if any), and common stock. You also know the following information of the company: The current price of the firm's $1.5/quarterly dividend, perpetual preferred stock is $110.14. • Currently, the company doesn't have any corporate bonds. However, the company's industries peers, similar size/business/risk, have outstanding corporate bonds, which might be useful to estimate the cost of debt (required return of bond) if the company issue bonds to raise capital: The current price of company A's 10 percent coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity is $1,140.72. The current price of company B's 8 percent coupon, semiannual payment, noncallable bonds with 10 years remaining to maturity is $1,200.30. ✓ The current price of company C's 12 percent coupon, semiannual payment, noncallable bonds with 13 years remaining to maturity is $1,350.54. • The company has 100,000 shares of stock outstanding, with a stock price of $143.5/share. Last year, the company had an EPS of $3 and paid a dividend of $90,000. The company also had a return on equity of 4.5 percent. You think the company will keep a constant DVD growth rate, which is close to this company's current growth rate. The firm's tax rate is 20 percent. After your analysis, you decide to only use corporate bond and common stock to raise capita thus, no preferred stocks). Your next task is to make a decision of the company's leverage. Thu Fou want to do a sensitivity analysis by estimating future cash flows based on different financi everage: Cash Flow with Different Leverage (in millions) Year 30% Debt 35% Debt 40% Debt 45% Debt -15 50% Debt -15 -15 WN Nu uw

Answer 1

Cost of preferred stock:

annual dividend= 1.5*4= $6

Cost of preferred stock = $6/ $110.14= 5.45%

Cost of equity:

Cost of equity= EPS/ Market share price

= 3/143.5 = 2.09%

Cost of debt :

Company B should be considered as the years to maturity being nearer to the required duration of debt.

hence cost of debt = interest (1-Tax expense)= 8(1-20%)= 6.64%

Since the cost of equity being lower compared to remaining options. The company should use equity capital the most.

Raising too much equity may result in loss of ownership of the company to persons who prejudicially affects the company interests.

if too much income is distributed as dividends it may cause in loosing growth opportunities.