Star Products Company is a growing manufacturer of automobile accessories whose stock is actively...

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Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter (OTC) market. During 2012, the Dallas-based company experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa Jen, the company’s treasurer, wants to make sure that available funds are being used to their fullest. Management policy is to maintain the current capital structure proportions of 30% long-term debt, 10% preferred stock, and 60% common stock equity for at least the next 3 years. The firm is in the 40% tax bracket. Star’s division and product managers have presented several competing investment opportunities to Jen. However, because funds are limited, choices of which projects to accept must be made. Star’s current investment opportunities are shown in the table below. Investment Opportunities for Star Products Company Investment opportunity Internal rate of return (IRR) Initial investment A 15% $400,000 B 22 200,000 C 25 700,000 D 23 400,000 E 17 500,000 F 19 600,000 G 14 500,000 To estimate the firm’s weighted average cost of capital (WACC), Jen contacted a leading investment banking firm, which provided the financing cost data shown in the following table. F
	
Document Preview: Unit 6 Case (Gitman Chapter 9) 
 
Making Star Products’ Financing/Investment Decision 
 
Star Products Company is a growing manufacturer of automobile accessories whose stock is 
actively traded on the over-the-counter (OTC) market. During 2012, the Dallas-based company 
experienced sharp increases in both sales and earnings. Because of this recent growth, Melissa 
Jen, the company’s treasurer, wants to make sure that available funds are being used to their 
fullest. Management policy is to maintain the current capital structure proportions of 30% 
long-term debt, 10% preferred stock, and 60% common stock equity for at least the next 3 
years. The firm is in the 40% tax bracket. 
 
Star’s division and product managers have presented several competing investment 
opportunities to Jen. However, because funds are limited, choices of which projects to accept 
must be made. Star’s current investment opportunities are shown in the table below. 
 
Investment Opportunities 
for Star Products Company 
Investment Internal rate of Initial 
opportunity return (IRR) investment 
A  15%  $400,000 
B XXXXXXXXXX,000 
C XXXXXXXXXX,000 
D XXXXXXXXXX,000 
E XXXXXXXXXX,000 
F XXXXXXXXXX,000 
G XXXXXXXXXX,000 
 
To estimate the firm’s weighted average cost of capital (WACC), Jen contacted a leading 
investment banking firm, which provided the financing cost data shown in the following table. 
 
Financing Cost Data 
Star Products Company 
Long-term debt: The firm can raise $450,000 of additional debt by selling 15-year, $1,000-
par-value, 9.0% coupon interest rate bonds that pay annual interest. It expects to net $960 per 
bond after flotation costs. Any debt in excess of $450,000 will have a before-tax cost, r , of 
d 
13.0%. 
Preferred stock: Preferred stock, regardless of the amount sold, can be issued with a $70 par 
value and a 14.0% annual dividend rate and will net $65 per share after flotation costs. 
Common stock equity: The firm expects dividends and earnings per share to be $0.96 and...

Robert · Accepted Answer

a. (1) Long-term debt, first $450,000: 
Before Cost of debt = {Coupon payments + [(Face Value – Net Price) / Years to maturity]} / {[(Net 
Price + Face Value) / 2]} 
 {$90 + [($1,000 - $960) / 15]} / {[$960 + $1,000] /2} 
 $92.67 / $980 = 0.0946 or 9.46% 
After-tax cost = Cost of debt x (1-tax rate) 
=> 9.46% x (1-0.40) = 5.68%
(2) Long-term debt, greater than $450,000: 
=> Cost of debt x (1-tax rate) 
=> 13% x (1-0.40) = 7.8%
(3) Cost of Preferred stock: 
Cost of preferred stock = Dividend / Price of preferred stock 
 $9.80 / $65 = 0.1508 or 15.08%
(4) Cost of Common stock equity, first $1,500,000: 
Cost of equity = (Expected Dividend / Sock Price) + Growth rate 
 ($0.96 / $12) + 0.11 = 0.19 or 19%
(5) Cost of Common stock equity, greater than $1,500,000: 
Cost of equity = (Expected Dividend / Sock Price net of floatation cost) + Growth rate 
 ($0.96 / $9) + 0.11 = 0.2166 or 21.66%
b. (1) Long-time debt less than 450,001 and common stock equity less than $1,500,001 
Type of Financing Weight in the Capital Structure (A) Cost (B) Weighted Cost of Capital (A*B) 
Debt 30.00% 5.71% 1.71% 
Preferred Stock 10.00% 15.08% 1.51% 
Equity 60.00% 19.00% 11.

Star Products Company is a growing manufacturer of automobile accessories whose stock is actively traded on the over-the-counter (OTC) market. During 2012, the Dallas-based company experienced sharp...

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