O'Grady Apparel
Cost of Financing and Break Points
Break
Point
(max of
low
Capital range/cap
Structu ital
structure Parts a
re
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
$700,000 and above
Preferred stock
$0 and above
Common Stock Equity
$0-$1,300,000
$1,300,000 and above
7.50%
10.80%
17.94%
23.80%
26%
50%
1,400,000
10%
40%
3,250,000
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)]
4
financing
Capital
(2)
(3)
Debt
0.25
7.50%
1.88%
0.1
17.89%
1.79%
$0 to $2,000,000 Preferred
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%
Preferred
0.1
17.89%
1.79%
$2,800,000 and above
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%
0.1
17.89%
1.79%
$0 to $1,400,000 Preferred
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%
0.1
17.89%
1.79%
$3,250,000 and abovePreferred
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
affect
thebecause they would have more financing ability.
investments
in part
c(2)
4
l New Financing
O'Grady Apparel
Cost of Financing and Break Points
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)=
Preferred stock
preferred diviend/preferred price
pg 511
$60*17%=$10.20
$10.20/57=
Common stock equity
D1/Nn+g
10.80%
$0 and above
17.94%
$0-1,300,000
$1.76/20+.15=
23.80%
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
$1,300,000 and above
1.76/16+.15=
26%
4