The Following Information Pertains to the Capital Program of a Firm

question 7

Essay

The following information pertains to the capital program of a firm:
Target capital structure: 30% debt, 20% preferred stock, 50% equity.
Unadjusted component costs of capital
k_d = 10%
k_p = 12%
k_e = 14%
Flotation Costs, Taxes, and Retained Earnings
Flotation costs are 8% on common and preferred stock and zero on debt
The total effective tax rate (federal and state) is 40%
Retained earnings of $1,250,000 are expected next year.
Investment Opportunities
$\begin{array}{lll}\text { Project } & \text { Investment } & \underline{\text { IRR }} \\\hline \text { A } & \text { \$1 million } & 13.0 \% \\\text { B } & \$ 2 \text { million } & 12.5 \% \\\text { C } & \$ 3 \text { million } & 11.8 \% \\D & \$ 1 \text { million } & 11.0 \%\end{array}$ a. Adjust the component costs of capital for taxes and flotation costs, and calculate the WACC before and after the first break.
b. Calculate the location of the break point.
c. Sketch the MCC and the IOS on the same graph. What is the cost of capital for the year? Why?
d. Which projects should the firm undertake? Why?

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Definitions:

Unconscious Attributions

The process of assigning causes to behaviors without conscious awareness, often based on implicit biases or heuristics.

Conscious Attributions

The process of deliberately reasoning about the causes of one's own or others' behavior and outcomes.

Situations

are sets of circumstances or contexts in which events occur, potentially influencing the behavior and outcomes of individuals involved.

Impression Management

The process through which individuals attempt to control the perceptions others have of them.