Reference no: EM132682969
Questions -
Lancaster Engineering Inc (LEI) has the following capital structure, which it considers to be optimal Debt 20%
Preferred stock 20%
Common equity 60%
LEI's expected net income this year is k34, 285.72: its established dividend payout ratio is 30%: its tax rate is 40% and investors expect future earnings and dividends to grow at a constant rate of 9%. LEI paid a dividend of k3. 60 per share last year, and its stock currently sells for k54. 00 per share. LEI can obtain new capital in the following ways:
Preferred: New preferred stock with a dividend of K11.00 can be sold to the public at a price of k95.00 per share.
Debt: Debt can be sold at an interest rate of 10%
a) i. Determine the cost of each capital component.
ii. Calculate the WACC.
b) Percy motors has a target capital structure of 40% debt and 60% common equity, with no preferred stock. The yield to maturity on the company's outstanding bond is 9% and its tax rate is 40%. Percy's CFO estimates that the company's WACC is 9.96%. What is Percy's cost of common equity?
c) Midwest Electric company (MEC) uses only debt and common equity. It can borrow unlimited amounts at interest rate of rd=10% as long as it finances at its target capital structure, which calls for 45% debt and 55%common equity. Its last dividend was $2, its expected constant growth rate is 4% and its common stock sells for $22. MEC's tax rate is 40%. These two projects are available: project A has a rate of return of 13%, while project b's return is 10%. These two projects are equally risky and about as risky as the firm's existing assets.
i) What is its cost of common equity?
ii) What is WACC?
iii) Which project should Midwest accept and why?
d) Explain why the cost of Retained Earnings is the same as the cost of common stock.
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