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    Finance Department of Ranch Manufactoring

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    As a memeber of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate of use when evaluating the purchase of new packing equipment for the plant. You have determined the market value of the firm's capital structure as follows:

    Source of Capital Market Values
    Bonds $4,000,000
    Preffered Stock $2,000,000
    Common Stock $6,000,000

    To finance the purchase, Ranch Manufactoring will sell 10-year bonds paying 7 percent per year at the market price of $1050. Flotation costs for issuing the bonds are 4 percent of the market price. Preffered Stock paying $2.00 dividen can be sold $25; the cost of issuing these shares is $3 per share. Common Stock for Ranch Manufactoring is currently selling for $55 per share. The firm paid a $3 dividen last year and expects dividends to continue growing at a rate of 10 percent per year. Flotation costs for issuing new common stock will be $5 per share and the firm's tax rate is 30 percent. What discount rate should you use to evaluate the equipment purchase?

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    Weighted Average cost of capital
    As a member of the Finance Department of Ranch Manufacturing, your supervisor has asked you to compute the appropriate discount rate of use when evaluating the purchase of new packing equipment for the plant. You have determined the market value of the firm's capital structure as follows:

    Source of Capital Market Values Weight
    Bonds $4,000,000 $4/$12 = 33.33%
    Preferred Stock $2,000,000 $2/$12 = 16.67%
    Common Stock $6,000,000 $6/$12 = 50%
    Total $12,000,000

    To finance the purchase, Ranch Manufacturing will sell 10-year bonds paying 7 percent per year at the market price of $1050. Flotation costs for issuing the bonds are 4 percent of the market price. Preferred Stock paying $2.00 dividend can be sold $25; the cost of issuing these ...

    Solution Summary

    This solution is comprised of a detailed explanation to answer what discount rate should you use to evaluate the equipment purchase.

    $2.19

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