J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after-tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. Ross expects to retain $15,000 in earnings over the next year. Ross' common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. Where will a break in the MCC schedule occur?
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A. B. C. D. E.E
Break point(RE) = $15,000/.50 = $30,000.
To determine where a break in the marginal cost of capital (MCC) schedule will occur for J. Ross and Sons Inc., we need to calculate the cost of each component of capital (debt, preferred stock, and common equity) and the weights assigned to each component in the target capital structure.
Given:
Target capital structure:
Cost of debt: 6% (after-tax)
Preferred stock details:
Common stock details:
To calculate the weighted average cost of capital (WACC) for J. Ross and Sons Inc., we first determine the cost of each component of capital and then calculate the weighted average.
Cost of Debt: The cost of debt is given as 6% after-tax. Since no additional information is provided, we can assume the tax rate to be 0% (or ignore the tax effect for simplicity).
Cost of Preferred Stock: The cost of preferred stock is the dividend yield. Dividend yield is calculated by dividing the dividend per share by the net proceeds per share from the sale of new preferred stock: Dividend yield = Dividend per share / Net proceeds per share Dividend yield = $10 / $80 = 0.125 or 12.5%
Cost of Common Equity: The cost of common equity is determined using the Dividend Discount Model (DDM). The DDM formula is: Cost of Equity = (Dividend / Current Stock Price) + Dividend Growth Rate
Given: Dividend = $2 per share Current Stock Price = $40 per share Dividend Growth Rate = 10%
Cost of Equity = ($2 / $40) + 0.10 = 0.05 + 0.10 = 0.15 or 15%
Weighted Average Cost of Capital (WACC) = (Weight of Debt * Cost of Debt) + (Weight of Preferred Stock * Cost of Preferred Stock) + (Weight of Common Equity * Cost of Common Equity)
Given: Weight of Debt = 40% Weight of Preferred Stock = 10% Weight of Common Equity = 50%
WACC = (0.40 * 0.06) + (0.10 * 0.125) + (0.50 * 0.15) WACC = 0.024 + 0.0125 + 0.075 WACC = 0.1115 or 11.15%
Now, let's examine the options provided to find the break in the MCC schedule:
A. $20,000 B. $10,000 C. $42,000 D. There will be no breaks in the MCC schedule. E. $30,000
To find the break in the MCC schedule, we need to identify the total investment amount where the cost of capital changes. This can occur if the weights of the components of capital change significantly.
Based on the information provided, we don't have any data related to changes in the capital structure or any restrictions on the weights assigned to each component. Therefore, the correct answer