Source of Capital Market Value

Bonds $3,500,000
Preferred Stock $1,800,000
Common Stock $5,900,000

To finance the purchase, Ranch manufacturing will sell 10 year bonds paying 6.6% per year at the market price of $1031. Preferred stock paying a $1.95 dividend can be sold for $25.53. Common stock for Ranch Manufacturing is currently selling for $54.38 per share and the firm paid a $2.98 dividend last year. Dividends are expected to continue growing at a rate of 5.4% per year into the indefinite future. If the firm’s tax rate is 30%, what discount rate should you use to evaluate the equipment purchase?

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Plan A is an all-common-equity structure in which $2.3 million dollars would be raised by selling 80,000 shares of common stock.

Plan B: would involve issuing $1.2 million dollars in long-term bonds with an effective interest rate of 11.7% plus $1.1 million would be raised by selling 40,000 shares of common stock. The debt funds raised under plan B have no fixed maturity date, in that this amount of financial leverage is considered a permanent part of the firm’s capital structure.

Abe and is partners plan to use a 34% tax rate in their analysis, and they have hired you on a consulting basis to do the following:
a. Find the EBIT indifference level associated with two financing plans.
b. Prepare a pre forma income statement for the EBIT level solved for in part a. that shows EPS will be the same regardless whether plan a or b is chosen.

“Plan A: is an all-common-equity capital structure. $2.1 million dollars would be raised by selling common stock at $10 per common share.

Plan B: involves the use of financial leverage. $1.1 million dollars would be raised by selling bonds with an effective interest rate of 11.3% (per annum), and the remaining $1.0 million would be raised by selling common stock at the $10 price per share. The use of financial leverage is considered to be a permanent part of the firm’s capitalization, so no fixed maturity date is needed for the analysis. A 35% tax rate is deemed appropriate for the analysis.”
a. Find the EBIT indifference level associated with two financing plans.
B. A detailed financial analysis of the firm’s prospects suggest that the long-term EBIT will be above $323,000 annually. Taking this into consideration, which plan will generate the higher EPS?

Crypton Electronics has a capital structure consisting of 44% common stock and 56% debt. A debt issue of $1000 par value, 5.7% bonds that mature in 15 years and pay annual interest will sell for $975. Common stock of the firm is currently selling for $29.45 per share and the firm expects to pay a $2.21 dividend next year. Dividends have grown at the rate of 5.1% per year and are expected to continue to do so for the foreseeable future. What is Cyrpton’s cost of capital where the firm’s tax rate is 30%.