Question

Boylan Metalworks Inc. has the following elements of capital:

Debt: Boylan issued $1,000, 30-year bonds 10 years ago at a coupon rate of 9%. Five thousand bonds were sold at par. Similar bonds are now selling to yield 12%.

Preferred Stock: Twenty thousand shares of 10% preferred stock were sold five years ago at their $100 par value. Similar securities now yield 13%.

Equity: The Company was originally financed with the sale of 1,000,000 shares at $10 per share. The stock is now selling at $12.50 per share.

Target Capital Structure:

Debt = 20%   Preferred Stock = 10%    Equity = 70%

Other Information:

Tax Rate = 40%

Flotation costs on sale of common stock = 10%

The Company is expected to grow at 6.5% indefinitely

The annual dividend paid in the current year was $1.10

Next years’ business plan includes earnings of $1,700,000, of which $1,400,000 will be retained

Compute the cost of debt, preferred stock, internal equity (retained earnings), and external equity (new equity)

Compute the WACC before and after the breakpoint

Compute the breakpoint

Answer 1

Step I: Calculation of Market Values and Weights

Debt:

Preferred Stock:

Given,

D_p -$10

K_p-0.13

Common Equity:

Calculation of Market Value Based Weights:

Step II: Calculation of Capital Component Costs

Debt Cost

Preferred Stock

Equity:

Equity-New Stock :

Step III: Calculation of WACC Break-Up

Capital Component	Weight	Pre-break Cost	Pre-Break Factor
Debt	0.216	0.072	0.0156
Preferred	0.086	0.144	0.0124
Equity	0.698	0.16	0.1117
		WACC	0.1397 or 13.97%

Capital Component	Weight	After-break Cost	After- Break Factor
Debt	0.216	0.072	0.0156
Preferred	0.086	0.144	0.0124
Equity	0.698	0.169	0.118
		WACC	0.1460or 14.60%

Therefore WACC before and after break is 14% and 14.6%

Step IV: Calculation of Break Point