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Solutions Guide: Please reword the answers to essay type parts so as to guarantee that

your answer is an original. Do not submit as your own.

Star Products Company: discuss sources of financing, break even, WACC Star Products

Company is a growing manufacturer of automobile accessories whose stock is activelytraded on the over-the-counter !"C# market$ %uring &''(, the %allas- based companye)perienced sharp increases in both sales and earnings$ *ecause of this recent growth,+elissa en, the companys treasurer, wants to make sure that available funds are beingused to their fullest$ +anagement policy is to maintain the current capital structureproportions of .'/ long-term debt, 0'/ preferred stock, and 1'/ common stock e2uityfor at least the ne)t . years$ "he firm is in the 3'/ ta) bracket$ Stars division and productmanagers have presented several competing investment opportunities to en$ 4owever,because funds are limited, choices of which pro5ects to accept must be made$ "heinvestment opportunities schedule 6!S# is as follows: 6nvestment !pportunitiesSchedule 6!S# for Star Products Company 6nvestment 6nternal rate of 6nitial opportunity

return 677# investment A 08/ 9 3'',''' * && &'',''' C &8 '',''' % &. 3'',''' ;0 8'',''' < 0( 1'',''' = 03 8'',''' "o estimate the firms weighted average cost ofcapital WACC#, en contacted a leading investment banking firm, which provided thefinancing cost data shown in the following table$ ong- term debt: "he firm can raise 9 38',''' ofadditional debt by selling 08-year, 90,'''- par- value, (/ coupon interest rate bonds thatpay annual interest$ 6t e)pects to net 9 (1' per bond after flotation costs$ Any debt ine)cess of 938',''' will have a before- ta) cost, rd, of 0./$ Preferred stock: Preferredstock, regardless of the amount sold, can be issued with a 9' par value and a 03/annual dividend rate and will net 918 per share after flotation costs$ Common stocke2uity: "he firm e)pects dividends and earnings per share to be 9'$(1 and 9.$&',

respectively, in &'0' and to continue to grow at a constant rate of 00/ per year$ "hefirms stock currently sells for 90& per share$ Star e)pects to have 90,8'',''' of retainedearnings available in the coming year$ !nce the retained earnings have been e)hausted,the firm can raise additional funds by selling new common stock, netting 9( per shareafter underpricing and flotation costs$ "o %o: a$ Calculate the cost of each source offinancing, as specified: 0# >ong- term debt, first 938','''$ >ong- term debt, greaterthan 938','''$ .# Preferred stock, all amounts$ 3# Common stock e2uity, first90,8'','''$ 8# Common stock e2uity, greater than 90,8'','''$ b$

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*elow 938',''':

&

#''',09?n

#?''',096

kd

d

d+

+

=

/31$('(31$(@'9

1:$(&9k

&

#''',09(1'908

#(1'9''',09('9

k

d

d

===

+

+

=

ki kd) 0 - t#ki ($31 ) 0 - $3#ki 8$1@/

Above 938',''': k i kd) 0 - t#ki 0.$' ) 0 - $3#ki $@/

Preferred Stock:

/'@$0808'@$189

@'$(9k

?

%k

p

p

pp

===

=

Common Stock Equity:

9' - 90,8'',''': k r %iP'# B g

kr 9$(1 90 B $00

kr $0( or 0(/

Above 90,8'',''': kn %i?n# B g

9$(1 9(# B $00

$&011 or &0$/

b. Breaking points

*reaking point i

5

W

Aong-term debt ''',8'',09.'$

''',38'9=

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*Pcommon e2uity 90, ,

$ 9&, ,

8'' '''

1' 8'' '''=

c. Weigted a!erage cost of capital:

"arget Capital Cost of Capital Weighted"#$ "ype of Capital Structure Source Costong-term debt $.' 8$/ 0$0/Preferred stock $0' 08$0/ 0$80/Common stock e2uity $1' 0($'/ 00 $3'/

0$'' WACC 03$1&/

"%$ ong-term debt $.' $@/ &$.3/Preferred stock $0' 08$0/ 0$80/

Common stock e2uity $1' 0($'/ 00 $3'/0$'' WACC 08$&8/

"&$ Above 9&,8'',''':>ong-term debt $.' $@/ &$.3/Preferred stock $0' 08$0/ 0$80/Common stock e2uity $1' &0$/ 0. $'&/

0$'' WACC 01$@/