On January 1, 2019, the total assets of the Dexter Company were $270 million. The firm'spresent capital structure, which follows, is considered to be optimal. Assume that there is noshort-term debt.Long-term Debt=$135,000,000 Common Stock=$135,000,000New bonds will have a 10 percent coupon rate and will be sold at par. Common stock, currently,selling at $60 a share, can be sold to net the company $54 a share. Stockholders' required rate ofreturn is estimated to be 12 percent., consisting of a dividend yield of 4 percent and an expectedgrowth rate of 8 percent. (The next expected dividend is $2.40, so $2.40/$60 = 4%.) Retained earnings are estimated to be $13.50 million. The marginal tax rate is 40 percent.Assuming that all asset expansion (gross expenditures for fixed assets plus related workingcapital) is included in the capital budget, the dollar amount of the capital budget, ignoringdepreciation is $135 million. The marginal tax rate is 40 percent. Assuming that all assetexpansion (gross expenditures for fixed assets plus related working capital) is included in thecapital budget, the dollar amount of the capital budget, ignoring depreciation is $135 million. Required:1. To maintain the present capital structure, how much of the capital budget must Dexterfinance by equity?2. How much of the new equity funds needed will be generated internally? Externally?3. Calculate the cost of each of the equity components. 4. At what level of capital expenditure will there be a break in Dexter’s Marginal Cost ofCapital schedule? 5. Calculate WACC.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
On January 1, 2019, the total assets of the Dexter Company were $270 million. The firm's
present capital structure, which follows, is considered to be optimal. Assume that there is no
short-term debt.
Long-term Debt=$135,000,000 Common Stock=$135,000,000
New bonds will have a 10 percent coupon rate and will be sold at par. Common stock, currently,
selling at $60 a share, can be sold to net the company $54 a share. Stockholders' required
return
growth rate of 8 percent. (The next expected dividend is $2.40, so $2.40/$60 = 4%.)
Assuming that all asset expansion (gross expenditures for fixed assets plus related working
capital) is included in the capital budget, the dollar amount of the capital budget, ignoring
depreciation is $135 million. The marginal tax rate is 40 percent. Assuming that all asset
expansion (gross expenditures for fixed assets plus related working capital) is included in the
capital budget, the dollar amount of the capital budget, ignoring depreciation is $135 million.
Required:
1. To maintain the present capital structure, how much of the capital budget must Dexter
finance by equity?
2. How much of the new equity funds needed will be generated internally? Externally?
3. Calculate the cost of each of the equity components.
4. At what level of capital expenditure will there be a break in Dexter’s Marginal Cost of
Capital schedule?
5. Calculate WACC.
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