Best Mix of Capital

ACME Corp is a publicly traded firm listed on the NASDAQ. Its current common stock price is 10 dollars per share. The company currently has 75 million dollars in sales. It expects sales to grow at 3 percent a year for the next several years. The company's current fixed costs are 50 million dollars. The federal tax rate is 40 percent. The variable costs are 22.5 million dollars this year. There are 1,000,000 shares outstanding.

The company has four capital projects that it would like to fund this year. If funded all four projects would be producing results for the firm one year from now. Project A has a life of 8 years, an initial investment of 2 million dollars, and an IRR of 12 percent. Project B has a 5 million dollar initial investment and a five-year life with an annual net cash income expected of 1,318,982 and an IRR of 10 percent. Project C has a life of 10 years, an IRR of 10 percent and a 4 million dollar initial investment. Project D is a 7-year project with an initial investment of 3 million dollars and a 9 percent IRR.

If the company uses debt, its investment banker suggests the following structure: 8 year maturity, equal annual principal repayments over the 8 years, and a 12 percent interest rate on outstanding principal.

The company pays no dividends on its common stock. The investment banker said to assume the firm would be able to issue common stock at the current market price, assuming the earnings per share will not be hurt in the future.

Preferred stock can be issued for a par value of 25 dollars per share and an annual dividend yield of 8 percent per share. Preferred dividends are not tax deductible to the company. Instead they are paid out of net income after taxes. Earnings per share on common stock should be calculated after preferred dividends have been paid. The numbers of shares of preferred stock are not included in the earnings per share calculation. This only includes common stock.

For this case, we are not going to require a marginal cost of capital analysis. Assume that all four projects are going to be done. The Price Earnings ratio that is calculated in problem number one should also be utilized, as appropriate in each of the five remaining problems to forecast the stock price.

Case Requirements

1. Prepare a baseline income statement and forecast for 2 years. (current year and forecast year 1 and forecast year 2) without the impact of the new capital program