XYC Co. is considering increasing the amount of debt in its capital structure.
The treasurer is worried about the ramifications of that action on the firm's cost of funds. The following information may be relevant to your analysis.
- The company's capital structure is as follows (figures are in book values):
Short-Term Bank Debt $6.2 million
Long-Term Bond $26.0 million
Preferred Stock $5.6 million
Common Equity (8.60 million shares)
$136 million
Total $173.8 million
- The bank debt is currently costing 8.2%.
- The bonds have a fixed 11% annual coupon, and mature in fourteen years. The price of the bonds is $109 (based on $100 par value).
- The preferred stock has 100 par value, pays an annual dividend of 6% of par, and is selling for $63 Y4 per share.
- The common stock is selling for $19 per share.
- The company's marginal tax rate is 34%.
- The beta of the firm's stock, given its current capital structure, is 0.9.
- Treasury bonds are currently yielding 7.1%.
- The market has historically earned 8.3% more than Treasury bonds.
If the company sells $10 million in bonds (at the prevailing market rate), and uses the proceeds to repurchase common stock, what will be Crocker's weighted-average cost of funds? Use
Beta (Unlevered) = EN x Beta (Levered) relationship.
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