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New Equity Issuance

New Equity Issuance. Cost of External Equity

ivan-hartman
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New Equity Issuance

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  1. New Equity Issuance • Cost of External Equity • Ex. Suppose Archer’s Aquarium Equipment may continue to issue unlimited amounts of common equity at a floatation cost of 8%. The firm recently paid a common stock dividend of $3 per share, and the firm’s dividends are expected to grow by 3% per annum. If the firm’s current stock price is $40 per share, what is the cost of external equity for Archer’s Aquarium Equipment?

  2. Weighted Average Cost of Capital • Given an optimal capital structure of 60% common equity, 30% debt, and 10% preferred stock, what is Archer’s Aquarium Equipment’s weighted average cost of capital (WACC) for capital budgets in excess of $50 million?

  3. Optimal Capital Budget • Investment Opportunity Schedule (IOS) - • Ex. Archer’s Aquarium Equipment can select among the following projects:

  4. Optimal Capital Budget % New Capital Raised • Which projects should Archer’s Aquarium Equipment undertake?

  5. Comprehensive Example • Ex. Ling’s Libation Barn has 4 potential capital investment projects with the following costs and rates of return: • LLB estimates it can issue debt with a before-tax cost of 10 percent, and its marginal federal-plus-state tax rate is 30 percent. Ling’s Libation Barn may also issue preferred stock at $50 per share, which pays a constant dividend of $5 per year. The floatation cost on preferred stock issuance is $1 per share. • In addition, net income is expected to be $250,000, and the firm plans to maintain its current dividend payout ratio of 40%. The firm’s stock is currently selling for $40 per share. The year-end dividend (D1) is expected to be $3.50, and the dividend growth rate is expected to be constant at 6% per year into the foreseeable future. Floatation costs of issuing new common stock equal $4 per share (F=10%), and LLB’s optimal capital structure consists of 75% common equity, 15% debt, and 10% preferred stock.

  6. Retained Earnings Break Point • What is LLB’s retained earnings break point?

  7. Capital Component Costs • What is LLB’s component cost of debt? • What is LLB’s component cost of preferred stock? • What is LLB’s component cost of retained earnings? • What is LLB’s component cost of new common equity?

  8. Weighted Average Cost of Capital • What is LLB’s weighted average cost of capital for capital budgets <$200,000? • What is LLB’s weighted average cost of capital for capital budgets > $200,000?

  9. Optimal Capital Budget • What should be the size of LLB’s optimal capital budget?

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