Problem:
Saven Travel Corporation is considering several investment opportunities in order to diversify its operations. Mr. Saven, president, is trying to determine the firm's cost of capital before he makes a decision. This diversification plan will require the firm to raise $400 million. A share of common stock is currently selling for $50, and the amount of the last dividend paid was $1.25. The company's earnings and dividends have been growing at about 12%, however, this is expected to drop to 9% per year in the future. Flotation costs of new common will be $4.00 per share. The firm can raise $150 million internally through retained earnings. The firm's investment dealer has informed Mr. Saven that this amount of equity can support $100 million in 12% coupon bonds. The company's tax rate is 46%.
Required:
Question 1: Compute the weighted average cost of capital on the first $250 million of funds.
Question 2: Saven Travel will need to raise $150 of additional capital for expansion. How much of this will be debt and equity?
Question 3: Compute the marginal cost of capital on the additional $150 million assuming the cost of debt stays the same.
Note: Be sure to show how you arrived at your answer.