Manchester Aeronautics Inc. (MAI) is presently a wholly equity financed company.

Manchester Aeronautics Inc. (MAI) is presently a wholly equity financed company. The firm desires to have the following target capital structure in its immediate future which is considered optimal for its performance:

Desired Capital Structure

TypeProportion

Debt25%

Preferred Stock15%

Common Equity60%

The firm is now very stable and is set to grow at a constant rate for several years to come. The firm declares and pays a dividend of $3.60 per share for its common stock holders today, and its common stock currently sells at $54 per share. The firm's EPS (earnings per share) was $8.40 in December 2007 and the same has grown to $16.80 this year, that is, December 2016. The firm's corporate tax rate is 40%.

MAI can obtain new capital in the following ways:

Preferred Stock: New Preferred Stock with a dividend of $11.00 can be sold to the public at the par value of $100.00 per share. The firm's investment bank managing the issue will charge a 5.00% (of the par value) underwriting commission for this issue.

Debt (Bond): Debt can be sold to investors who will require $120.00 coupon interest per year per bond. Coupon interest paymet will be made annually. The underwriting fee for bankers on this issue is being written off as an operating expense for this year.

Assume that the firm is successful in raising the required capital. The equity stockholders' expected rate of return will not change after the new securities are issued.

1. Determine the pre-tax cost of each capital structure component in percentage (3 x 1 = 3 points):

(a) Common Equity 

%

(b) Preferred Stock 

%

(c) Debt 

%

2. Determine the after-tax cost of each capital structure component in percentage(3 x 1 point each = 3 points): 

(a) Common Equity 

%

(b) Preferred Stock 

%

(c) Debt 

%

3. Calculate the firm's weighted average cost of capital (WACC) (1 point) 

%

4. The firm is considering raising $100 million from the bond (debt) market. Assume that the firm is successful in raising the money. What will be the interest expense for the $100 million debt each year? (1 point) $

5. If the current yield on treasury securities is 5.00% and the market risk premium is 6.50%, what is your best estimate of MAI's beta? (1 point) 

6. If the firm has $100 million debt in bonds, what is its total capital? (1 point) $