SOURCE OF FINANCING Bonds TARGET CAPITAL STRUCTURE WEIGHTS 40% Common Stock 60% The firm currently has one issue of bonds outstanding. The bonds have a par value of $1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity, and are selling for $1,035. Nealon's common stock has a current market price of $35, and the firm paid a $2.50 dividend last year that is expected to increase at an annual rate of 6 percent for the foreseeable future. a. What is the yield to maturity for Nealon's bonds under current market conditions? b. What is the cost of new debt financing to Nealon based on current market prices after both taxes (you may use a 21 percent marginal tax rate for your estimate) and flotation costs of $30 per bond have been considered? c. What is the investor's required rate of return for Nealon's common stock? If Nealon were to sell new shares of common stock, it would incur a cost of $2.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common stock? d. Compute the weighted average cost of capital for Nealon's investment us- ing the weights reflected in the actual financing mix (that is, $20 million in retained earnings and $50 million in bonds). e. Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the $70 million in new capital, or $28 million, using $20 million in retained earnings and raising $22 million through a new equity offering. f. If you were the CFO for the company, would you prefer to use the calculation AO TATE a G + 196.
SOURCE OF FINANCING Bonds TARGET CAPITAL STRUCTURE WEIGHTS 40% Common Stock 60% The firm currently has one issue of bonds outstanding. The bonds have a par value of $1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity, and are selling for $1,035. Nealon's common stock has a current market price of $35, and the firm paid a $2.50 dividend last year that is expected to increase at an annual rate of 6 percent for the foreseeable future. a. What is the yield to maturity for Nealon's bonds under current market conditions? b. What is the cost of new debt financing to Nealon based on current market prices after both taxes (you may use a 21 percent marginal tax rate for your estimate) and flotation costs of $30 per bond have been considered? c. What is the investor's required rate of return for Nealon's common stock? If Nealon were to sell new shares of common stock, it would incur a cost of $2.00 per share. What is your estimate of the cost of new equity financing raised from the sale of common stock? d. Compute the weighted average cost of capital for Nealon's investment us- ing the weights reflected in the actual financing mix (that is, $20 million in retained earnings and $50 million in bonds). e. Compute the weighted average cost of capital for Nealon where the firm maintains its target capital structure by reducing its debt offering to 40 percent of the $70 million in new capital, or $28 million, using $20 million in retained earnings and raising $22 million through a new equity offering. f. If you were the CFO for the company, would you prefer to use the calculation AO TATE a G + 196.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:SOURCE OF FINANCING
Bonds
TARGET CAPITAL STRUCTURE WEIGHTS
40%
Common Stock
60%
The firm currently has one issue of bonds outstanding. The bonds have a par value of
$1,000 per bond, carry an 8 percent coupon rate of interest, have 16 years to maturity,
and are selling for $1,035. Nealon's common stock has a current market price of $35,
and the firm paid a $2.50 dividend last year that is expected to increase at an annual
rate of 6 percent for the foreseeable future.
a. What is the yield to maturity for Nealon's bonds under current market conditions?
b. What is the cost of new debt financing to Nealon based on current market
prices after both taxes (you may use a 21 percent marginal tax rate for your
estimate) and flotation costs of $30 per bond have been considered?
c. What is the investor's required rate of return for Nealon's common stock? If
Nealon were to sell new shares of common stock, it would incur a cost of $2.00
per share. What is your estimate of the cost of new equity financing raised
from the sale of common stock?
d. Compute the weighted average cost of capital for Nealon's investment us-
ing the weights reflected in the actual financing mix (that is, $20 million in
retained earnings and $50 million in bonds).
e. Compute the weighted average cost of capital for Nealon where the firm
maintains its target capital structure by reducing its debt offering to 40 percent
of the $70 million in new capital, or $28 million, using $20 million in retained
earnings and raising $22 million through a new equity offering.
f. If you were the CFO for the company, would you prefer to use the calculation
AO TATE a
G
+ 196.
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