Ask Financial Management Expert

The Marietta Corporation, a large manufacturer of mufflers, tailpipes, and shock absorbers, is currently carrying out its financial planning for next year. In about two weeks, at the next meeting of the firm’s board of directors, Frank Bosworth, vice president of finance, is scheduled to present his recommendations for next year’s overall financial plan. He has asked Donna Botello, manager of financial planning, to gather the necessary information and perform the calculations for the financial plan. The company’s divisional staff s, together with corporate finance department personnel, have analyzed several proposed capital expenditure projects. The following is a summary schedule of acceptable projects (defined by the company as projects having internal rates of return greater than 8 percent): Project Investment Amount Internal Rate of Return (in Million of Dollars) A $10.0 25% B 20.0 21 C 30.0 18 D 35.0 15 E 40.0 12.4 F 40.0 11.3 G 40.0 10 H 20.0 9 All projects are expected to have one year of negative cash flow followed by positive cash flows over the remaining years. In addition, next year’s projects involve modifications and expansion of the company’s existing facilities and products. As a result, these projects are considered to have approximately the same degree of risk as the company’s existing assets. Botello feels that this summary schedule and detailed supporting documents provide her with the necessary information concerning the possible capital expenditure projects for next year. She can now direct her attention to obtaining the data necessary to determine the cost of the capital required to finance next year’s proposed projects. The company’s investment bankers indicated to Bosworth in a recent meeting that they feel the company could issue up to $50 million of 9 percent first-mortgage bonds at par next year. The investment bankers also feel that any additional debt would have to be subordinated debentures with a coupon of 10 percent, also to be sold at par. The investment bankers rendered this opinion after Bosworth gave an approximate estimate of the size of next year’s capital budget, and after he estimated that approximately $100 million of retained earnings would be available next year. Both the company’s financial managers and its investment bankers consider the present capital structure of the company, shown in the following table, to be optimal (assume that book and market values are equal): Debt $ 400,000,000 Stockholders’ equity: Common stock 150,000,000 Retained earnings 450,000,000 $1,000,000,000 Botello has assembled additional information, as follows: • Marietta common stock is currently selling at $21 per share. • The investment bankers have also indicated that an additional $75 million in new common stock could be issued to net the company $19 per share. • The company’s present annual dividend is $1.32 per share. However, Bosworth feels fairly certain that the board will increase it to $1.415 per share next year. • The company’s earnings and dividends have doubled over the past 10 years. Growth has been fairly steady, and this rate is expected to continue for the foreseeable future. The company’s marginal tax rate is 40 percent. Using the information provided, answer the following questions. (Note: Disregard depreciation in this case.) 1. Calculate the after-tax cost of each component source of capital. 2. Calculate the marginal cost of capital for the various intervals, or “packages,” of capital the company can raise next year. Plot the marginal cost of capital curve. 3. Using the marginal cost of capital curve from question 2, and plotting the investment opportunity curve, determine the company’s optimal capital budget for next year. 4. Should Project G be accepted or rejected? Why? 5. What factors do you feel might cause Bosworth to recommend a different capital budget than the one obtained in question 3? 6. Assume that a sudden rise in interest rates has caused the cost of various capital components to increase. The pretax cost of first-mortgage bonds has increased to 11 percent; the pretax cost of subordinated debentures has increased to 12.5 percent; the company’s common stock price has declined to $18; and new stock could be sold to net Marietta $16 per share. a. Re compute the after-tax cost of the individual component sources of capital. b. Re compute the marginal cost of capital for the various intervals of capital Marietta can raise next year. c. Determine the optimal capital budget for next year at the higher cost of capital. d. How does the interest rate surge affect Marietta’s optimal capital budget?

Financial Management, Finance

  • Category:- Financial Management
  • Reference No.:- M91546428

Have any Question?


Related Questions in Financial Management

Assignment problems1 on the day harry was born his parents

Assignment Problems 1. On the day Harry was born, his parents put $1600 into an investment account that promises to pay a fixed interest rate of 5 percent per year. How much money will Harry have in this account when he ...

1 activities of a company that require the spending of cash

1) Activities of a company that require the spending of cash are known as: A) Uses of cash. B) Cash on hand. C) Cash receipts. D) Sources of cash. E) Cash collections. 2) Relationships determined from a firm's financial ...

Module discussion forumto prepare for this discussion

Module : Discussion Forum To prepare for this discussion, review "Basics of Speechwriting" and "Basics of Giving a Speech" in textbook Chapter 15. Then watch this video of Apple founder and CEO Steve Jobs giving the 2005 ...

Launching a new product linefor this portfolio project

Launching a New Product Line For this Portfolio Project Option, you will act as an employee in a large company that develops and distributes men's and women's personal care products. The company has developed a new produ ...

Question 1 discuss valuing bonds and how interest rates

Question : 1) Discuss valuing bonds and how interest rates affect their value. Also consider the importance of the yield-to-maturity (YTM). 2) Discuss common stocks and preferred stocks. Also, which common stock valuatio ...

Introductionlast week you determined the root causes of the

Introduction Last week, you determined the root cause(s) of the problem you are trying to resolve for your final paper. As a reminder, the decision you are working on is the one that you selected in week two. This week, ...

You have owned and operated a successful brick-and-mortar

You have owned and operated a successful brick-and-mortar business for several years. Due to increased competition from other retailers, you have decided to expand your operations to sell your products via the Internet. ...

You will be conducting an interview with a market research

You will be conducting an interview with a market research professional or a company representative. Use the results of your research to make specific recommendations on how market research can be applied to the Marketpl ...

Question 1 what is marketing research what are the two

Question 1: What is marketing research? What are the two primary types of research? Question 2: What factors influence marketing research? Question 3: The role of statistics in business decision-making? Assignment : Sele ...

Chapter 74 for commercial banks what is meant by a managed

Chapter 7 4. For commercial banks, what is meant by a managed liability? What role do liquid assets play on the balance sheet of commercial banks? What role do money market instruments play in the asset and liability man ...

  • 4,153,160 Questions Asked
  • 13,132 Experts
  • 2,558,936 Questions Answered

Ask Experts for help!!

Looking for Assignment Help?

Start excelling in your Courses, Get help with Assignment

Write us your full requirement for evaluation and you will receive response within 20 minutes turnaround time.

Ask Now Help with Problems, Get a Best Answer

Why might a bank avoid the use of interest rate swaps even

Why might a bank avoid the use of interest rate swaps, even when the institution is exposed to significant interest rate

Describe the difference between zero coupon bonds and

Describe the difference between zero coupon bonds and coupon bonds. Under what conditions will a coupon bond sell at a p

Compute the present value of an annuity of 880 per year

Compute the present value of an annuity of $ 880 per year for 16 years, given a discount rate of 6 percent per annum. As

Compute the present value of an 1150 payment made in ten

Compute the present value of an $1,150 payment made in ten years when the discount rate is 12 percent. (Do not round int

Compute the present value of an annuity of 699 per year

Compute the present value of an annuity of $ 699 per year for 19 years, given a discount rate of 6 percent per annum. As