The Target Company and issues within their stock, Since it’s inception Eco Plastics Company 1

| January 30, 2017

Question
The Target Company and issues within their stock, Since it’s inception Eco Plastics Company has been revolutionizing plastic and and trying to do its part to save the environment. Eco’s founder Marion Cosby developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern United States. After operating as a private company for 6 years , Eco went public in 2009 and listed on the Nasdaq stock exchange. As the chief financial officer of a young company with lots of investment oppurtunities , Eco’s CFO closely monitors the firms cost of capital. The CFO keeps tabs on each of the individual costs of Eco’s three main financing sources : long term debt, preferred stock, and common stock. The target Capital structure of ECO is given in weights as follows : Source of capital Long Term Debt………………… 30% Preferred Stock…………………. 20% Common Stock Equity ……… 50% Total………………………………….100% At the present time , Eco can raise debt by selling 20 year bonds with a $1000 par value and a 10.5% annual coupon interest rate. Eco’s corporate tax rate is 40% and its bonds generally require an average discount of $45 per bond ad flotation costs of $32 per bond. When being sold. Eco’s oustanding preferred stock pays a 9% dividend and has a 95 per share par value. The cost of issuing and selling additional preferred stock is expected to be $7 per share. Because Eco is a young firm that requires lots of cash to grow it does not currently pay a dividend to stockholders. To track the cost of common stock the CFO uses the capital asset pricing model. (CAPM) The CFO and the firms investment advisers believe that the appropriate risk free rate is 4% and the markets expected return equals 13%. Using the data from 2009-2012, Eco’s CFO estimates the firms beta to 1.3. Although Eco’s current target capital structure includes 20% preferred stock,the company is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long term 50% common stock. If Eco shifts its capital stock to debit, its financial advisers expect the beta to increase to 1.5.

A. Calculate Eco’s current after tax cost of long term debt.

B.Calculate Eco’s cost of preferred stock

C.Calculate Eco’s current cost of common stock.

D.Calculate Eco’s current weighted average of cost capital.

E.

1. Assuming that the debt financing costs do not change , what effect would a shift to more highly leveraged capital structure consisting of 50% long term debt, 0% preferred stock, and 50% common stock have on the risk premium for Eco’s common stock? What would be Eco’s new cost of common equity.

2.What would Eco’s new weighted average cost of capital?

3.Which capital structure- the original one or this one, which is better? why?

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