'Eco Plastic Solution Essay\r'

'This case focuses on determination of the terms of cap for a firm. The student determines the damage of singular sources of backing, including long-term debt, preferred air, and honey oil stock. The cost of debt is adjust for Eco Plastics’ 40% tax bracket. The company is considering a equationvenu pecuniary structure, with the replacement of preferred stock backing with debt financing. Additional use of debt increases the common stockholders’ studyd evaluate of return. The student is asked to compare the two charge reasonable costs of capital and identify the better pecuniary structure for Eco Plastics Company.\r\na. Cost of debt:\r\nProceeds from sale of $1,000 par revalue bond:\r\n$1,000 ∠(average discount & floatation costs)\r\n$1,000 ∠($45 + $32) = $923\r\nSubsequent payments: Interest payments ($1,000 à 0.105) + Par value\r\nBefore-tax cost of debt\r\nN = 20, PV = $923, PMT = âˆ105, FV = âˆ1,000\r\nSolve for I = 11.50%\r\nAfter-ta x cost of debt: ri = rd (1-T) = 11.5% (1âˆ0.4) = 6.9%\r\nb. Cost of preferred stock: rp = Dp ÷ Np\r\n= (0.095 à $95) ÷ ($95 †$7)\r\n= $9.02 ÷ $88\r\n= 10.25%\r\nc. Cost of common stock: rj = RF + [bj à (rm ∠RF)]\r\n= 0.04 + [1.3 à (0.13 ∠0.04)]\r\n= 0.04 + [1.3 à 0.09]\r\n= 0.04 + 0.1170\r\n= 15.7%\r\nd. Weighted average cost of capital: ra = (wi à ri) + (wp à rp) + (ws à rn)\r\n= (0.30 à 0.069) + (0.20 à 0.1025) + (0.50 à 0.157)\r\n= 0.0207 + 0.0205 + 0.785\r\n= 0.1197, or about 12%\r\ne. 1. variety show in risk Premium: Change in beta à market risk premium = (1.5 ∠1.3) à (0.13 ∠0.04)\r\n= 0.2 à 0.09 = 0.018\r\nShareholders require 1.8% more per year\r\nNew cost of common equity: rj = RF + [bj à (rm ∠RF)]\r\n= 0.04 + [1.5 à (0.13 ∠0.04)]\r\n= 0.04 + [1.5 à 0.09]\r\n= 0.04 + 0.1350\r\n= 17.5%\r\nNote: 17.5% ∠15.7% = 1.8%\r\n2. Revised weighted average cost of capital: ra= (wi x ri) + (ws x rn) = (0.50 à 0.069) + (0.50 à 0.175)\r\n= 0.0345 + 0.0875\r\n= 0.1220\r\n3. Eco Plastics’ CFO should retain the cheaper current financial structure. Replacing preferred stock financing with debt financing results in more risk to the stockholders. The increase in stockholders’ required rate of return is more than offsets the service of using the low cost debt. If Eco Plastics’ CFO were to revise the capital structure, share price would fall and shareholder wealth would not be maximized.\r\n'