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O'Grady Apparel

Cost of Financing and Break Points


Break
Point
(max of
low
Capital range/cap
Structu ital
re structure Parts a
Source of Capital Range of new financing
After-tax cost Weight
(%) weight and b(1)
Long-term debt $0-$700,000 7.50% 25% 2,800,000
$700,000 and above 10.80%
Preferred stock $0 and above 17.94% 10%
Common Stock Equity
$0-$1,300,000 23.80% 65% 2,000,000
$1,300,000 and above 26%

Capital
Structu
re
Source of Capital Range of new financing
After-tax cost Weight
(%) Break Point
Part d (1)
Long-term debt $0-$700,000 7.50% 50% 1,400,000
$700,000 and above 10.80%
Preferred stock $0 and above 17.94% 10%
Common Stock Equity
$0-$1,300,000 23.80% 40% 3,250,000
$1,300,000 and above 26%

4
O'Grady Apparel
Cost of Financing and Break Points
b (2) and (3). Weighted Average Cost of Capital for Ranges of Total New Financing
for O'Grady Apparel Company
Weighted
Cost
Range of total new Source of Weight Cost [(2)x(3)]
financing Capital (2) (3) 4
Debt 0.25 7.50% 1.88%
$0 to $2,000,000 Preferred 0.1 17.89% 1.79%
Common 0.65 23.80% 15.47%
Weighted Average Cost of Capital 19.13%
Debt 0.25 7.50% 1.88%
$2,000,001 to
Preferred 0.1 17.89% 1.79%
$2,800,000
Common 0.65 26.00% 16.90%
Weighted Average Cost of Capital 20.56%
Debt 0.25 10.80% 2.70%
$2,800,000 and above Preferred 0.1 17.89% 1.79%
Common 0.65 26% 16.90%
Weighted Average Cost of Capital 21.39%

(1). Weighted Average Cost of Capital for Ranges of Total New Financing for O'Grady Apparel Comp
Weighted
Cost
Range of total new Source of Weight Cost [(2)x(3)]
financing Capital (2) (3) 4
Debt 0.5 7.50% 3.75%
$0 to $1,400,000 Preferred 0.1 17.89% 1.79%
Common 0.4 23.80% 9.52%
Weighted Average Cost of Capital 15.06%
Debt 0.5 10.80% 5.40%
$1,400,001 to
Preferred 0.1 17.89% 1.79%
$3,250,000
Common 0.4 23.80% 9.52%
Weighted Average Cost of Capital 16.71%
Debt 0.5 10.80% 5.40%
$3,250,000 and abovePreferred 0.1 17.89% 1.79%
Common 0.4 26% 10.40%
Weighted Average Cost of Capital 17.59%

d. (2) The capital structure in d. is preferred. It allows the firm to finance investment opportunities at
cost and 25% LTD in the capital structure seems low.
e. (1) O'Grady Apparel Compay appears to employ the Constant-Payout-Ration Dividend Policy. It doe
seem appropriate given the firms current investment opportunities. Further it could jeopardize their f
stock prices if their earnings decrease and therefore dividends decrease and shareholders are worried
stability of the firm.
e. (2) Low-Regular-and-Extra Dividend Policy is recommended. This would allow the firm to
have more control of equity available for financing as well as protect the stability of the stock
price. It would
investments affect
in part thebecause they would have more financing ability.
c(2)

4
O'Grady Apparel
Cost of Financing and Break Points
l New Financing

r O'Grady Apparel Company

vestment opportunities at a lower

on Dividend Policy. It does not


it could jeopardize their future
d shareholders are worried about

llow the firm to


bility of the stock

4
O'Grady Apparel
Cost of Financing and Break Points
After tax cost of debt: 0-$700,000
Used calculator for rd:
N=10
PV=970
PMT=-120 (.12*1000)
FV=-1000
Compute for I=12.5428
ri=rd*(1-T)
.125*(1-.40) 7.50%

After tax cost of debt: above $700,000


.18*(1-.40)= 10.80%

Preferred stock $0 and above


preferred diviend/preferred price
pg 511
$60*17%=$10.20
$10.20/57= 17.94%

Common stock equity $0-1,300,000 $1,300,000 and above


D1/Nn+g $1.76/20+.15= 1.76/16+.15=
23.80% 26%
D1= per share diviend expect at end of year 1
Nn=net proceeds from the sale of new common stock
g=constant growth in dividends