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ogrady_apparel_case_study100an_2_1.docxRunning Head:O’GRADY APPAREL CASE STUDY 1
O’GRADY APPAREL CASE STUDY 4
Integrative Case 6 O’Grady Apparel Company
Name of student
Name of paper
Professor’s name
Date Due
Answer;
From part a , after-tax –cost for each source of financing under respective ranges are :
|
Source of capital |
Range of New Financing |
After -Tax -Cost(%) |
|
Long -Term Debt |
$0-$700,000 |
12.5%*(1-0.4)=7.50% |
|
|
$700,000 and above |
18%*(1-0.4)=10.80% |
|
Preferred Stock |
$0 and above |
17%*(1-0.4)==17.94% |
|
Common stock equity |
$0 - $1,300,000 |
($1.76/$20)*100%+15%=23.80% |
|
|
$1,300,000 and above |
($1.76/$16)*100%+15%= 26% |
Calculations ;
Cost of debt =rd(1-T)
For the range $0-$700,000;rd=12.5%
Before tax cost of debt, rd ={ I+(par-value -Nd)/n}/{(Nd+Par value)/2}, where Nd Nd=Net process from sales=Sales-Flotation cost - Premium (or discount), I= Interest in dollars, n= Number of years of maturity
rd={I+($1000-Nd)/n}/{(Nd+$1000)/2}
= {120+($1000-$970)/10}/{($970+$1,000)/2} = 0.125 or 12.5%
Assuming leveraged capital structure consisting of 50% long-term debt, 10% preferred stock, and 40% common stock , the breakeven points for common stock and long term debt are;
Common stock equity;$1,300,000/40% =$3,250,000
Long term debt: $700,000/50%= $1, 400,000
Thus the new Weighted Average Cost of Capital (WACC) capital structure ;
|
Range |
Calculations |
WACC |
|
$0- $1,400,000 |
(0.5*0.075)+(0.10 *0.179) +(0.40*0.238) |
15.060% |
|
$1,400,001 - $3,250,000 |
(0.5*0.108)+(0.10 *0.179) +(0.40*0.238) |
16.710% |
|
Above $3,250,000 |
(0.5*0.108)+(0.10 *0.179) +(0.40*0.260) |
17.590% |
From b) , the break even points are ;
Common stock equity ;$1,300,000/65% =$2,000,000
Long term debt: $700,000/25%= $2, 800,000
|
Range |
Calculations |
WACC |
|
$0- $2,000,000 |
(0.25*0.075)+(0.10 *0.179) +(0.65*0.238) |
19.135% |
|
$2,000,001 - $2,800,000 |
(0.25*0.075)+(0.10 *0.179) +(0.65*0.26) |
20.565% |
|
Above $3,250,000 |
(0.25*0.108)+(0.10 *0.179) +(0.65*0.260) |
21.390% |
d.)1.The effect of shifting to a capital structure that includes more debt while keeping the cost of each financing source the same is that , it will lead to change in the weighted average cost of the capital(WACC) .
d.)2 . A more leveraged capital structure usually has a lower weighted average cost of capital. The cost of equity is greater than cost of debt. In this regard the cost of capital of the new capital structure ( capital structure consisting of 50% long-term debt, 10% preferred stock, and 40% common stock ,) is lower than the cost of capital of the original capital structure. Therefore , the new capital structure seems better than the original one. Nevertheless, the new capital structure is coupled with more financial risk as it includes more debt .
