Cost of reinvested profits versus new common shares - DVM. Using the data for each firm shown in the following table, calculate the cost of reinvested profits and the cost of new common shares using the constant-growth DVM.
|
Firm
|
Current market price per share
|
Dividend growth rate
|
Current dividend per
share
|
Discount per share
|
Flotation cost per share
|
|
A
|
$52.00
|
8%
|
$2.25
|
$2.00
|
5% of selling price
|
|
B
|
20.00
|
4
|
1.00
|
0.50
|
1.50
|
|
C
|
42.50
|
6
|
2.00
|
1.00
|
6% of selling price
|
|
D
|
19.00
|
2
|
2.10
|
1.30
|
1.70
|
9-21 WAC, MCC, and IOS Cartwell products has compiled the data shown in the following table, for the current costs of its three sources of capital - long -term debt, preferred equity, and common equity - for various ranges of new financing.
|
Source of capital
|
Range of new financing
|
After-tax cost
|
|
Long-term debt
|
$1 to $320,000
$320,001 and above
|
6%
8%
|
|
Preferred equity
|
$1 and above
|
17%
|
|
Common equity
|
$1 to $200,000
$200,001 and above
|
20%
24%
|
The company's optimal capital structure, which is used to calculate the weighted average cost of capital, is shown in the following table.
|
Source of capital
|
Weight
|
|
Long-term debt
|
40%
|
|
Preferred equity
|
20
|
|
Common equity
|
40
|
|
Total
|
100%
|
a. Determine the break points and ranges of new financing associated with each source of capital. At what financing levels will Cartwell's weighted average cost of capital change?
b. Calculate the weighted average cost of capital for each range of total new financing found in a.
c. Using the results of b along with the following information on the available investment opportunities, draw the firm's marginal cost of capital (MCC) schedule and investment opportunities schedule (IOS).
|
Investment Opportunity
|
Expected return (IRR)
|
Initial investment
|
|
A
|
19%
|
$200,000
|
|
B
|
15
|
300,000
|
|
C
|
22
|
100,000
|
|
D
|
14
|
600,000
|
|
E
|
23
|
200,000
|
|
F
|
13
|
100,000
|
|
G
|
21
|
300,000
|
|
H
|
17
|
100,000
|
|
I
|
16
|
400,000
|
|
|
|
|
d. Which, if any, of the available investments do you recommend that the firm select? Explain your answer.
e. Now calculate the overall cost of capital for Cartwell Products. Which projects should the firm select? Does your answer differ from your answer to part d? If so, explain why?