It is expected that you prepare a report based on information provided below. You should approach this from the perspective of upper-level managers. Included in the report should be:
1) An evaluation of projects based on information provided below 2) A discussion of other things that may need to be considered (theoretically as no information about the characteristics of the projects is provided beyond independence/mutual exclusivity). 3) A suggestion of which projects should be accepted, in order of preference, and which should be rejected. 4) An evaluation of the Marginal Cost of Capital (weighted average cost of capital on a marginal basis) 5) A suggestion of what level of funds should be supplied through retained earnings, new debt, new issue of preferred stock and new issue of common stock. 6) A discussion of how dividend policy may affect the decision of capital investment.
Guidelines
Your assignment will be evaluated on the following: 1) Formatting of the document: a. Introduction explaining the purpose, structure and methodology of the paper b. Main body providing an analysis of the items listed above. c. Conclusion providing recommendations based on your analysis (from a manager’s perspective) d. Reference list including all sources cited and no other sources. e. Supporting information can be included in appendices; all calculations required should appear clearly labeled in appendices. The analysis in the main body of the report should only be based on and discuss the final values calculated and compared.
2) Proper citing and referencing
Information required to evaluate project options, and cost of capital and funding options.
Three projects being considered. Projects A1 and A2 are mutually exclusive (based on equipment that would be supplied from two different sources) and Project B which is independent of the A projects.
Following are the projected cash flows of the projects: Year Project A1 Project A2 Project B 0 $(20,000,000) $(22,500,000) $(52,000,000) 1 10,000,000 10,000,000 20,000,000 2 9,000,000 12,000,000 20,000,000 3 12,000,000 7,000,000 20,000,000 4 — 5,000,000 20,000,000
Using the MCC which you will calculate based on the information below, determine which project/s should be accepted. Discuss the techniques used and how your decision of which project/s to accept is influenced by the techniques used.
The company has an optimal capital structure of 50% debt, 10% preferred stock and 40% common equity. The corporation’s current tax rate is 30%.
a) The company currently borrows funds at an average rate of 10%. Find the after tax cost of debt.
b) The price of preferred stock today is $125. Floatation fees are $5.50. The annual dividend on outstanding preferred stock is $12.00. Find the cost of issuing new preferred stock.
c) The price of common stock today is $25.60, the most recent dividend was $1.95 and growth is expected to remain constant at 5%. The flotation cost of issuing new common stock is 10% of the price. Find the cost of retained earnings and the cost of issuing new common stock.
d) If the company expects to retain $420,000 in earnings over the next year, find the breaks in the MCC curve.
e) Using the component funding rates found above and the breaks in the MCC curve found above, calculate the different levels of marginal cost of capital.
