Concept explainers
Eco Plastics Company
Since its inception, Eco Plastics Company has been revolutionizing plastic and trying to do its part to save the environment. Eco’s founder, Marion Cosby, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for 6 years, Eco went public in 2012 and is listed on the Nasdaq stock exchange.
As the chief financial officer of a young company with lots of investment opportunities, Eco’s CFO closely monitors the firm’s cost of capital. The CFO keeps tabs on each of the individual costs of Eco’s three main financing sources: long-term debt,
Source of capital | Weight |
Long-term debt | 30% |
Preferred stock | 20 |
Common stock equity | 50 |
Total | 100% |
At the present time, Eco can raise debt by selling 20-year bonds with a $1,000 par value and a 10.5% annual coupon interest rate. Eco’s corporate tax rate is 40%, and its bonds generally require an average discount of $45 per bond and flotation costs of $32 per bond when being sold. Eco’s outstanding preferred stock pays a 9% dividend and has a $95-per-share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Eco is a young firm that requires lots of cash to grow, it does not currently pay a dividend to common stockholders. To track the cost of common stock, the CFO uses the
Although Eco’s current target capital structure includes 20% preferred stock, the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long-term debt and 50% common stock. If Eco shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5.
To Do
- a. Calculate Eco’s current after-tax cost of long-term debt.
- b. Calculate Eco’s current cost of preferred stock.
- c. Calculate Eco’s current cost of common stock.
- d. Calculate Eco’s current weighted average cost capital (WACC).
- e. 1. Assuming that the debt financing costs do not change, what effect would a shift to a more highly leveraged capital structure consisting of 50% long-term debt, 0% preferred stock, and 50% common stock have on the risk premium for Eco’s common stock? What would be Eco’s new
cost of common equity ? - 2. What would be Eco’s new weighted average cost of capital (WACC)?
- 3. Which capital structure- the original one or this one-seems better? Why?
Trending nowThis is a popular solution!
Chapter 9 Solutions
Gitman: Principl Manageri Finance_15 (15th Edition) (What's New in Finance)
- MAG Petroleum is an SME specialising in the sale of lubricants for industrial use. The company, which is owned and operated by Angelina, has just completed its third year operation. During this time, Angelina has sought to establish a reputation for the company as a supplier of high quality lubricants. The efforts made by Angelina and her staff have proved successful, and her company has become one of the best and fastest growing privately owned company in Zambia.Angelina has concluded that in order to plan better for the growth of the company in the future, it is necessary to develop assistance that will enable her to forecast lubricant sales by month for up to one year in advance. Angelina has available data on the total lubricant sales that were realized during the previous three years of operation. These data are provided in Table Q2.(a) What forecasting method would you recommend to Angelina? Justify your choicearrow_forwardJohn Snow has recently retired, and he received a large lump sum settlement from his employer. He would like to invest this money to achieve a stable long term income. He is considering investing in the following two companies: Allied Grocers (AG) are a 3-year-old online grocery retailer that specializes in delivering a wide selection of quality food products through an online platform. Beta Solutions (BS) is an established 10-year-old electronics company that is known for selling the most innovative electronic products and software solutions. Selected financial data for 2019 AG BS Average total assets 1,500,000 4,000,000 Average # of common shares outstanding (no preferred shares) 10,000 10,000 Dividends paid 10,000 50,000 Current Market price per share $95 $165 Net sales 1,300,000 6,300,000 Cost of goods sold 900,000 4,200,000 Gross profit 400,000 2,100,000 Operating Expenses: Administrative…arrow_forwardNextG Limited is a leading manufacturer of automotive components. It supplies to the original equipment manufacturers as well as the replacement market. Its projects typically have a short life as it introduces new models periodically. You have recently joined NextG Limited as a financial analyst reporting to Mr. Atiamoh, the CFO of the company. He has provided you the following information about two mutually exclusive projects. A and B, that are being considered by the Executive Committee of NextG Limited:Project A is an extension of an existing line. Its cash flow will decrease over time. Project B involves a new product. Building its market will take some time and hence its cash flow will increase over time.The expected net cash flows of the two mutually exclusive projects are as follows. Mr. Atiamoh believes that all the two projects have risk characteristics similar to the average risk of the firm and hence NextG’s cost of capital of 10 percent will apply to them and both…arrow_forward
- Warf Computers, Inc., was founded 15 years ago by Nick Warf, a computer programmer. The small initial investment to start the company was made by Nick and his friends. Over the years, this same group has supplied the limited additional investment needed by the company in the form of both equity and short- and long-term debt. Recently the company has developed a virtual keyboard (VK). The VK uses sophisticated artificial intelligence algorithms that allow the user to speak naturally and have the computer input the text, correct spelling and grammatical errors, and format the document according to preset user guidelines. The VK even suggests alternative phrasing and sentence structure, and it provides detailed stylistic diagnostics. Based on a proprietary, very advanced software/hardware hybrid technology, the system is a full generation beyond what is currently on the market. To introduce the VK, the company will require significant outside investment. Nick has made the decision to seek…arrow_forwardSarah Welch was hired 15 years ago by Produce-R-Us, an importer of rare and exotic fruits. ProduceR-Us was started by an immigrant family 20 years ago and has grown to a national company with sales of $10 million annually. Although the business has grown, the family-owned business strives to maintain a “family atmosphere” and stresses trust. Because of Sarah’s honesty and hard work, the manager quickly promoted her, and she now signs checks for amounts under $5,000 and also has responsibilities for Accounts Payable. Now, however, the owners are suspicious of Sarah’s recent lifestyle changes and have hired you to determine whether Sarah is embezzling from the company. Public records reveal the following:Perform a net worth calculation using the data above.arrow_forwardExtreme Inc. is a newly established enterprise. It was set up by an entrepreneur who is generally interested inthe business of providing engineering and operational support services to aircraft manufacturers. ExtremeInc., through the contacts of its owner, received a confirmed order from a well-known aircraft manufacturerto develop new designs for ducting the air conditioning of their aircraft. For this project, Extreme Inc.needed funds aggregating to $1 million. It was able to convince venture capitalists and was able to obtainfunding of $1 million from two Silicon Valley venture capitalists. The expenditures Extreme Inc. incurred inpursuance of its research and development project follow, in chronological order: • January 15, 20X5: Paid $175,000 toward salaries of the technicians (engineers and consultants) • March 31, 20X5: Incurred $250,000 toward cost of developing the duct and producing the test model • June 15, 20X5: Paid an additional $300,000 for revising the ducting process…arrow_forward
- Extreme Inc. is a newly established enterprise. It was set up by an entrepreneur who is generally interested in the business of providing engineering and operational support services to aircraft manufacturers. Extreme Inc., through the contacts of its owner, received a confirmed order from a well- known aircraft manufacturer to develop new designs for ducting the air conditioning of their aircraft. For this project, Extreme Inc. needed funds aggregating to $1 million. It was able to convince venture capitalists and was able to obtain funding of $1 million from two Silicon Valley venture capitalists. The expenditures Extreme Inc. incurred in pursuance of its research and development project follow, in chronological order: January 15, 2015: Paid $175,000 toward salaries of the technicians (engineers and consultants) March 31, 2015: Incurred $250,000 toward cost of developing the duct and producing the test model June 15, 2015: Paid an additional $300,000 for revising the ducting process…arrow_forwardCBA Company is engaged in producing quality cars. Its mission is to be a dominant player in car manufacturing industry in Southern Tagalog Region. You were hired as a management accountant of the company. It has come to your attention that ABC Aluminum Inc, an aluminum manufacturer is up for sale for P 500 million. The value of net underlying assets is P 450 million, with the remaining amount was attributable to its Research and Development (R & D) department. You also learned that aluminum is one of the materials used in car manufacturing. The reason why ABC Aluminum came to your attention is the fact that it also throws off P 40 million in tax benefits through rapid tax depreciation of equipment. The purchase of ABC Aluminum would be financed thru a bank with 10% annual interest. Note: Corporate tax rate is 30%. 1. Is the acquisition of ABC Aluminum aligned with CBA's strategic plan? Explain your answer. 2. Will there be an increase in value-added? By how much? Please show…arrow_forwardCryogenics Inc., is a leading developer, designer, and manufacturer of tanks, moveable containers, and trailers for the most efficient storage and distribution of liquid helium and hydrogen. Cryogenics started as a private company when founded in 1960 by industrialist William Hodges. It has since gone public and has grown to support a staff 250 employees between its Tulsa, Oklahoma, and Prague, Czech Republic, operations to meet the global demand for liquid helium and hydrogen storage with the highest performance ratings in the industry. The following describes Cryogenics fixed asset system. Asset acquisition begins when the department manager recognizes the need to obtain or replace an existing fixed asset. The manager prepares two copies of a purchase requisition; one is filed in the department, and one is sent to the purchasing department. The purchasing department uses the purchase requisition to prepare three copies of a purchase order. One copy of the purchase order is sent to the supplier, another copy is sent to the AP department, and the third copy is filed in the purchasing department. Vendors ship the ordered items to Cryogenics receiving department along with the packing slip. The receiving clerk then prepares three copies of a receiving report. One copy of the receiving report is sent to AP, one is sent to the department manager, and one is sent to the inventory department clerk who uses it to update the inventory records. A few days later the vendor sends an invoice to the AP clerk, which the clerk reconciles with the purchase order and receiving report. The AP clerk inputs the information into the computer terminal, posts the liability, updates the purchase journal, and prints out hard copies of a journal voucher and cash disbursement voucher. The journal voucher is sent to the general ledger department, and the cash disbursement voucher and the suppliers invoice are sent to the cash disbursements department. The purchase order and the receiving report are filed in the AP department. Using the information from the suppliers invoice and the cash disbursement voucher, the cash disbursements clerk prepares a hard copy check in payment of the liability, sends the check to the vendor, and posts it to the check register. Finally, the clerk sends the cash disbursement voucher to the general ledger department. Periodically, the department manager adjusts the fixed asset inventory subsidiary account balances to reflect asset depreciation and sends an asset status summary to the general ledger. The general ledger department clerk reconciles the cash disbursements voucher, the journal voucher, and the asset status summary, and posts to the general ledger accounts. Required a. Prepare the REA model to support the fixed asset procedures. b. Show the cardinalities for all associations. c. List the tables, keys, and attributes needed to implement this model in a relational database.arrow_forward
- Harriet Moore is an accountant for New World Pharmaceuticals. Her duties include tracking research and development spending in the new product development division. Over the course of the past six months, Harriet has noticed that a great deal of funds have been spent on a particular project for a new drug. She hears “through the grapevine” that the company is about to patent the drug and expects it to be a major advance in antibiotics. Harriet believes that this new drug will greatly improve company performance and will cause the company’s stock to increase in value. Harriet decides to purchase shares of New World in order to benefit from this expected increase. Required What are Harriet’s ethical responsibilities, if any, with respect to the information she has learned through her duties as an accountant for New World Pharmaceuticals? What are the implications of her planned purchase of New World shares?arrow_forwardHardevarrow_forwardA philanthropist is looking to invest in new start-up companies. She has decided to invest $200,000 in a company started by two inventors. It is decided the philanthropist will earn a 10% return on her investment and then the profits of the new company will be divided into the ratio 1:2:2. The philanthropist is represented by the first person in the ratio. Determine the amount the philanthropist receives and the amount each inventor receives if the profit is $78,000arrow_forward
- Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax CollegeManagerial Accounting: The Cornerstone of Busines...AccountingISBN:9781337115773Author:Maryanne M. Mowen, Don R. Hansen, Dan L. HeitgerPublisher:Cengage Learning
- Accounting Information SystemsAccountingISBN:9781337619202Author:Hall, James A.Publisher:Cengage Learning,Auditing: A Risk Based-Approach to Conducting a Q...AccountingISBN:9781305080577Author:Karla M Johnstone, Audrey A. Gramling, Larry E. RittenbergPublisher:South-Western College Pub