FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information is provided for your analyses—
1. The market price of common stock is $60/ share
2. The dividend next year is expected to be $3/share
3. The company has paid 10% dividends in the past; the company projected to keep that rate of dividend payments to keep their investors happy.
4. New bonds can be issued at face value with a 10% coupon rate in order to attract additional investors in bonds and not in stocks.
5. The total liabilities as of this date is $400M and total equity is $600M. The company considered this their optimal capital structure.
6. As of the latest investor relations press meeting, the CEO announced that the expected revenue will grow as projected and the intend to retain $3M of the earning for expansion plans.
7. The firm’s marginal tax rate is 40%.
Without prejudice, assume that the after-tax cost of debt financing is 10% , the cost of retained earnings is 14%, and the cost of new common stock is 16%.
Question 1: If the capital expansion needs to be $7M for the coming year, what is the after-tax weighted-average cost of capital?
Question 2: What is the marginal cost of capital for any projected capital expansion in excess of $7M?