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Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal: LEI's expected net income this year is Sh.34,285.72; its established dividend payout...

      

Lancaster Engineering Inc. (LEI) has the following structure, which it considers to be optimal:
fig102041007.png
LEI's expected net income this year is Sh.34,285.72; its established dividend payout ratio is 30
percent; its marginal tax rate is 40 percent; and investors expect earnings and dividends to grow at a
constant rate of nine percent in the future. LEI paid a dividend of Sh.3.60 per share last hear, and its stock currently sells at a price of Sh.60 per share.
LEI can obtain new capital in the following ways:
Common: New common stock has a flotation cost of ten percent for up to Sh.12,000 of new stock and
20percent for all common stock over Sh.12,000.
Preferred: New preferred stock with a dividend of Sh.11 can be sold to the public at a price of Sh.100
per share. However, flotation costs of Sh.5 per share will be incurred for up to Sh.7,500 of preferred stock, and flotation costs will rise to Sh.10 per share, or ten percent, on all preferred stock over Sh.7,500.
Debt: Up to Sh.5,000 of debt can be sold at an interest rate of 12 percent; debt in the range of Sh.5,001 to Sh.10,000 must carry an interest rate of 14 percent; and all debt over Sh.10,000 will have an interest rate of 16 percent.
LEI has the following independent opportunities:
fig112041008.png
(a) Find the break points in the MCC schedule
(b) Determine the cost of each capital structure component.
(c) Calculate the weighted average cost of capital in the interval between each break in the
MCC schedule.
(d) Calculate the IRR for Project E.
(e) Construct a graph showing the MCC and IOS schedules.
(f) Which projects should LEI accept?

  

Answers


Kavungya
fig122041009.png
fig132041009.png
fig142041010.png

(f) LEI should accept Projects B, E, and C. It should reject Projects A and D because their IRRS do not exceed the marginal costs of funds needed to finance them. The firm's capital budget would total
Sh.40,000.
Kavungya answered the question on April 20, 2021 at 19:11


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