The Capital Structure For Mills Corporation Is Shown Below

The Capital Structure For Mills Corporation Is Shown Below Current

The capital structure for Mills Corporation is shown below. Currently, flotation costs are 13% of market value for a new bond issue and $3 per share for preferred stock. The dividends for common stock were $2.50 last year and have an estimated annual growth rate of 6%. Market prices are $1,050 for bonds, $20 for preferred stock, and $40 for common stock. Assume a 34% tax rate. Financing Type % of Future Financing Bonds (8%, $1k par, 16-year maturity) 36% Common equity 45% Preferred stock (5k shares outstanding, $50 par, $1.50 dividend) 19% Total % 100% Compute the company’s WACC. The Milton Company plans to issue preferred stock. Currently, the company’s stock sells for $120. Once new stock is issued, the Milton Company would receive only $99 (due to flotation costs). The dividend rate is 12%, and the par value of the stock is $100. Compute the cost of capital of the stock to your firm. Show all work. The Dayton Corporation is considering a new investment, which would be financed from debt. Dayton could sell new $1k par value bonds at a new price of $950. The bonds would mature in 15 years, and the coupon interest rate is 10%. Compute the after-tax cost of capital to Dayton for bonds, assuming a 34% tax rate. Show work. Farrah Corporation is considering two projects (see below). For your analysis, assume these projects are mutually exclusive with a required rate of return of 12%. Project 1 Project 2 Initial investment $185,000 $1,100,000 Cash inflow Year 1 $230,000 $1,450,000 Compute the following for each project: · NPV (net present value) · PI (profitability index) · IRR (internal rate of return) Which project should be selected? Why?

Paper For Above instruction

The financial decision-making process for corporations involves a detailed analysis of various components of their capital structure, cost of capital, and investment projects. Understanding these elements allows firms like Mills Corporation, Milton Company, Dayton Corporation, and Farrah Corporation to optimize their financial strategies, maximize shareholder value, and ensure sustainable growth. This paper explores the calculations for weighted average cost of capital (WACC), cost of preferred stock, after-tax cost of debt, and project evaluation metrics such as Net Present Value (NPV), Profitability Index (PI), and Internal Rate of Return (IRR) to provide comprehensive insights into corporate financial management.

Calculating the Weighted Average Cost of Capital (WACC) for Mills Corporation

The WACC is a crucial metric used by firms to evaluate the cost of financing their operations through a mix of debt, preferred stock, and common equity. For Mills Corporation, the weights are given as 36% for bonds, 45% for common equity, and 19% for preferred stock. The respective costs are calculated considering flotation costs, market prices, and tax impacts.

First, the cost of debt (Kd) is derived from the bond details. The bonds have an 8% coupon rate on a $1,000 face value, trading at $1,050. The yield to maturity (YTM) needs to be calculated to determine the effective cost of debt:

Using the YTM formula or financial calculator:

PV = -$1,050 (price)

FV = $1,000 (par value)

PMT = $80 (8% of $1,000)

n = 16

The approximate YTM (before tax) is calculated as:

YTM ≈ [Coupon Payment + (Face Value - Price)/Years] / [(Price + Face Value)/2]

YTM ≈ [$80 + ($1,000 - $1,050)/16] / [($1,050 + $1,000)/2]

YTM ≈ [$80 - $3.125] / $1,025

YTM ≈ 0.0755 or 7.55%

Adjusting for taxes:

K_d (after tax) = 7.55% × (1 - 0.34) ≈ 4.99%

Next, the cost of preferred stock (K_p) considers flotation costs:

Dividend (D_p) = $1.50

Market price (P_p) = $20

Flotation cost per share = $3

Net proceeds = $20 - $3 = $17

K_p = D_p / Net proceeds = $1.50 / $17 ≈ 8.82%

For the cost of equity (K_e), using the dividend growth model:

K_e = (D₁ / P₀) + g = ($2.50 × 1.06) / $40 + 0.06 ≈ ($2.65) / $40 + 0.06 ≈ 6.63% + 6% = 12.63%

Now, compiling all these into the WACC formula:

WACC = (W_d) × K_d + (W_p) × K_p + (W_e) × K_e

= 0.36 × 4.99% + 0.19 × 8.82% + 0.45 × 12.63%

= 1.7964% + 1.6758% + 5.6835%

≈ 9.16%

Cost of Preferred Stock for Milton Company

Milton Company’s preferred stock sells at $120, but net proceeds after flotation costs are $99. Dividend per share is 12% of the par value ($100), so:

D_p = 12% × $100 = $12

K_p = D_p / Net proceeds = $12 / $99 ≈ 12.12%

This rate represents the cost of issuing preferred stock to Milton Company, which is crucial for calculating the weighted average cost of capital.

After-Tax Cost of Debt for Dayton Corporation

Dayton has bonds with a par value of $1,000, selling for $950, a 10% coupon rate, and 15-year maturity:

Coupon payment = 10% × $1,000 = $100

YTM approximation:

YTM ≈ [$100 + ($1,000 - $950)/15] / [($950 + $1,000)/2]

= [$100 + $50/15] / $975

= [$100 + 3.33] / 975 ≈ 0.1067 or 10.67%

Adjusting for taxes:

K_d (after tax) = 10.67% × (1 - 0.34) ≈ 7.05%

Evaluation of Mutually Exclusive Projects: NPV, PI, IRR

For both projects, calculations involve discounting cash inflows at the required rate of return (12%).

Project 1:

- Initial Investment = $185,000

- Year 1 Cash Inflow = $230,000

- Assuming cash flows occur immediately and only in Year 1 for simplicity (or using annuity formulas if multiple years are specified).

NPV is calculated as:

NPV = (Cash Inflows / (1 + r)^t) - Initial Investment

NPV = $230,000 / (1 + 0.12) - $185,000 ≈ $205,357 - $185,000 = $20,357

Profitability Index (PI):

PI = Present Value of inflows / Initial Investment ≈ $205,357 / $185,000 ≈ 1.11

IRR is the rate where NPV = 0:

Setting up the equation:

$230,000 / (1 + IRR) - $185,000 = 0

IRR ≈ ($230,000 / $185,000) - 1 ≈ 1.243 - 1 ≈ 0.243 or 24.3%

Project 2:

- Initial Investment = $1,100,000

- Year 1 Cash Inflow = $1,450,000

- NPV:

NPV = $1,450,000 / (1 + 0.12) - $1,100,000 ≈ $1,295,536 - $1,100,000 = $195,536

PI:

PI = $1,295,536 / $1,100,000 ≈ 1.18

IRR:

IRR ≈ ($1,450,000 / $1,100,000) - 1 ≈ 1.318 - 1 ≈ 31.8%

Project Selection and Conclusion

Both projects have positive NPVs and IRRs exceeding the required rate of return of 12%. However, Project 2 has a higher NPV and IRR, making it more financially desirable. Given the mutual exclusivity, the company should select Project 2, as it provides a higher return and value addition.

Conclusion

Effective financial decision-making relies on rigorous analysis of weighted costs of capital and investment project metrics. The computed WACC for Mills Corporation at approximately 9.16% reflects an optimal mix of debt, equity, and preferred stock costs. The preferred stock cost for Milton Company at 12.12% indicates the expense of equity financing through preferred shares. Dayton’s bond financing offers an after-tax cost of about 7.05%, showing the impact of taxes on debt costs. Lastly, the project evaluation demonstrates that selecting projects with higher NPVs, PIs, and IRRs—like Project 2—maximizes shareholder value and supports strategic growth.

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