Medical Research Corporation has been expanding its production capacity and research to introduce a new product line. Current plans call for spending $ 100 million in four projects of the same magnitude ($ 25 million each), but offer different performance. Project A is on proteins for blood clotting and has an expected return of 18%. Project B is related to a vaccine for hepatitis and includes an expected return of 14%. The C project, which is a cardiovascular compound, has expectations to win 11.8%, and D project, an investment of orthopedic implants, has the expectation of showing a 10.9% yield.
The company has $ 15 million in retained earnings. After a capital structure is reached with $ 15 million in retained earnings (in which the retained earnings account for 60% of funding), any additional equity financing should be channeled in the form of new common capital.
The common stock sold at a price of $ 25 per share and insurance costs have been estimated at $ 3 if the new shares are issued. The dividends for the following year will be $ 0.90 per share (D), and profits and dividends have consistently grown 11% per year.
The comparative performance of bonds has been hovering around 11%. The investment banker feels that the first $ 20 million of bonds could be sold so that changeover yield 11% while the additional debt may require a premium of 2% and sold so that changeover yield 13%. The corporate tax rate is 30%. The debt represents 40% of the capital structure.
a. Based on the two sources of funding, is the cost of initial capital weighted average? (Use K and K)