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Week 8 AssignmentWeighted Average Cost of Capital (WACC)
1. The capital structure for Mills Corporation is shown below. Currently, flotation costs are 13% of market value for a new bond issue and $3 per share for preferred stock. The dividends for common stock were $2.50 last year and have an estimated annual growth rate of 6%. Market prices are $1,050 for bonds, $20 for preferred stock, and $40 for common stock. Assume a 34% tax rate.
| Financing Type | % of Future Financing |
| Bonds (8%, $1k par, 16 year maturity) | 36% |
| Common equity | 45% |
| Preferred stock (5k shares outstanding, $50 par, $1.50 dividend) | 19% |
| Total % | 100% |
Compute the company’s WACC.
| WACC | 36% | 5.97% | |||
| PS | 19% | 8.82% | |||
| CS | 45% | 6.63% | |||
2. The Milton Company plans to issue preferred stock. Currently, the company’s stock sells for $120. Once new stock is issued, the Milton Company would receive only $99 (due to flotation costs). The dividend rate is 12%, and the par value of the stock is $100. Compute the cost of capital of the stock to your firm. Show all work.
3. The Dayton Corporation is considering a new investment, which would be financed from debt. Dayton could sell new $1k par value bonds at a new price of $950. The bonds would mature in 15 years, and the coupon interest rate is 10%. Compute the after-tax cost of capital to Dayton for bonds, assuming a 34% tax rate. Show work.
4. Farrah Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 12%.
| Project 1 | Project 2 | |
| Initial investment | $(185,000) | $(1,100,000) |
| Cash inflow Year 1 | $230,000 | $1,450,000 |
Compute the following for each project:
| -185000 | -1100000 | |
| 230000 | 1450000 | |
| $205,357.14 | $1,294,642.86 | |
| $20,357.14 |
| NPV |
| 1.11 |
| PI |
| 24% |
| IRR |
Which project should be selected? Why?
