Reference no: EM13618922

Balance Sheet 2010

Type of financing

Bonds (8%, $1,000 par, 30-year maturity)                                                           38%

Preferred stock (5,000 shares outstanding, $50 par, $1.50 dividend)                 15%

Common stock                                                                                                     47%

Total                                                                                                                     100%

The Nealon Manufacturing Company paid dividends to its common stockholders of $2.50 per share last year, and the projected rate of annual growth in dividends is 6% per year. Nealon's common stock trades over-the-counter and has a current market price of $35 per share. In addition, the firm's bonds have a AA rating. Moreover, AA bonds are currently yielding 7%. The preferred stock has a current market price of $19 per share.

a. If the firm is in a 34% tax bracket, what is the weighted average cost of capital (WACC)?

b. In the analysis done so far we have not considered the effects of flotation costs. Assume now that Nealon is raising a total of $40 million using the above financing mix. New debt financing will require that the firm pay 50 basis points (1/2 a percent) in issue costs, the sale of preferred stock will require the firm to pay 200 basis points in flotation costs, and the common stock issue will require flotation costs of 500 basis points.

i. What are the total flotation costs the firm will incur to raise the needed $40 million?

ii. How should the flotation costs be incorporated into the analysis of the $40 million investment the firm plans to make?