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Case 19: Determining the Cost of Capital The Oceanic Corporation, a Chesapeake, VA based company, was established in 1994.
Case and additional information is attached.Case 19: Determining the Cost of CapitalThe Oceanic Corporation, a Chesapeake, VA based company, was established in 1994. Glenn Rodgers III founded the corporation, which was privately owned at the time, after his retirement from Norentech Corporation. Table 1The Oceanic CorporationBalance Sheet('000s)Cash 5000Accounts Receivables 10000Inventory 20000Total Current Assets 35000Land & Buildings (net) 43000 Plant and Equipment (net) 45000Total Fixed Assets 88000 Total Assets123000 Accounts Payable 8000Accruals 5000Notes Payable 10000Total Current Liabilities 23000Long-term debt 40000Retained Earnings 10000Common stock(5 million shares outstanding) 50000Total liabilities and shareholders' equity 123000Table 2The Oceanic CorporationSales, Earnings, and Dividend History('000s)Year Sales EPSDividends/Share1998 $24,000,000 $0.48 $0.101999 28,800,000 0.58 0.122000 36,000,000 0.72 0.152001 45,000,000 0.86 0.182002 51,750,000 0.96 0.202003 62,100,000 1.06 0.222004 74,520,000 1.20 0.25Questions:1. Why do you think Larry Stone wants to estimate the firm's hurdle rate? Is it justifiable to use the firm's weighted average cost of capital as the divisional cost of capital? Please explain.2. How should Stephanie go about figuring out the cost of debt? Calculate the firm's cost of debt.3. Comment on Stephanie's assumptions as stated in the case. How realistic are they?4. Why is there a cost associated with a firm's retained earnings?5. How can Stephanie estimate the firm's cost of retained earnings? Should it be adjusted for taxes? Please explain.6. Calculate the firm's average cost of retained earnings.7. Can flotation costs be ignored in the analysis? Explain.8. How should Stephanie calculate the firm's hurdle rate? Calculate it and explain the various steps.9. Can Larry assume that the hurdle rate calculated by Stephanie would remain constant? Please explain.
