1.     burton currently has $850,000 of long-term debt outstanding,

1.     Burton currently has $850,000 of long-term debt outstanding, 5,000 shares of preferred stock ($10 par) with a market price of $12, and 20,000 shares of common stock ($20 par) with a market price of $53 per share.  They have used a WACC of 14% in the past to evaluate projects but want to determine their current required return for new investments.

 

 

 

Debt: Burton can sell a 10-year, $1,000 par value, 7 percent annual coupon bond for $975. A flotation cost of 2 percent of the face (par) value would be required. Additionally, the firm has a marginal tax rate of 34 percent.

 

 

 

Preferred Stock:  Burton pays $1 dividends annually on their preferred shares.  The shares are currently selling for $12 in the secondary market.  They do not have plans to issue any additional preferred stock.

 

 

 

Common Stock: Burton’s common stock is currently selling for $53 per share. The dividend expected to be paid at the end of the coming year is $4. Its dividend payments have been growing at a constant 3% rate.  It is expected that to sell all the shares, a new common stock issue must be underpriced $1 per share and the firm must pay 1% of market value per share in flotation costs.

 

 

 

a.     Calculate the after-tax cost of debt

 

b.     Calculate the cost of preferred equity

 

c.     Calculate the cost of common equity

 

d.     Calculate the WACC

 

e.     Re-calculate the NPV for the project in #1 above using this new WACC.

 

f.      Should Burton accept the project when considering this revised cost of capital?

 

 

 

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