Type of financing % of future financing bonds(8%,$1,000 par, 16 yr. maturity) 38

Question

Type of financing % of future financing
bonds(8%,$1,000 par, 16 yr. maturity) 38%
preferred stock(5,000 shares outstanding,
$50 par, $1.50 dividend) 15%
Common equity 47%
Total 100%

Assuming Nealon would have sufficient retained earnings such that it would not need to sell additional common stock to finance it's new investments, consider the situation now, when Nealon's retained earnings anticipated for the coming year are expected to fall short of the equity requirement of 47% of new capital raised. Consequently, the firm foresees the possibility that new common shares will have to be issued. To facilitate the sale of shares, Nealon's investment banker has advised management that they should expect a price discount of approximately 7%, or $2.45 per share. Under these terms, the new shares should provide net proceeds of about $32.55. What is Nealon's cost of capital equity when new shares are sold, and what is the weighted average cost of the added funds involved in the issuance of new shares average cost of the added funds involved in the issuance of the new shares?

Explanation / Answer

Here Weights are Debt (wD)= 0.38 Prefered stock(wP) =0.15 Eqity (wE)= 0.47 Costs Debt(rD)= 8% Tax = Not given Preferd rP= 1.50/50 = 3% Equity = 2.45 /32.55 = 7.52% Weigted avarage cost of capital = wE*rE+wP*rP+wD*rD(1-Tc) 0.47*7.52%+ 0.15*3%+0.38*8% = 0.0045+0.0353+0.0304 =7.02%

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