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Category: Business and Industry

Date Submitted: 09/30/2012 09:16 AM

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Medical Research Corporation is expanding its research and production capacity to introduce a new line of products. Current plans call for the expenditures of $100 million on four projects of equal size ($25 million each), but different returns. Project A is in antiblood-clotting proteins and has an expected return of 18%. Project B relates to a hepatitis vaccine and carries a potential return of 14%. Project C dealing with a cardiovascular compound, is expected earn 11.8%, and Project D, an investment in orthopedic implants, is expected to show a 10.9% return. The firm has $15 million in retained earnings. After a capital structure with $15 million in retained earnings is reached (in which retained earnings represents 60 % of the financing), all additional equity financing must come in the form of new common stock. Common stock is selling for $25 per share and underwriting costs are estimated at $3 if new shares are issued. Dividends for the next year will be 90 cents per share D1), and earnings and dividends have grown consistently at 11% per year. The yield on comparative bonds has been hovering at 11%. The investment banker feels that the first $20 million of bonds could be sold to yield 11% while additional debt might require a 2% premium and be sold to yield 13%. The corporate tax rate is 30%. Debt represents 40% of the capital structure. a). Based on the two sources of financing, what is the initial weighted average cost of capital? (use Kd and Ke). b). At what size capital structure will the firm run out of retained earnings? c). What will the marginal cost of capital be immediately after that point? d). At what size capital structure will there be a change in the cost of debt? e). What will the marginal cost of capital be immediately after that point? f). Based on the information about potential returns on investments in the first paragraph and information on marginal cost of capital ( in parts a, c, and e) how large a capital investment budget should the...