Case Study: On January 1, the total market value of the Tysseland Company was $60 million.
On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest $30 million in new projects. The company’s current capital structure, which is as follows, is assumed to be optimal. There is no short term debt.
Common stock $30,000,000
Total Capital $60,000,000
The new bonds will have a coupon rate of 8% and will be sold at par. Common stock is currently selling for $30 per share. The shareholder’s required rate of return is estimated at 12%, consisting of a 4% dividend yield and an expected constant growth rate of 8%. (The expected dividend is $1.20, so the dividend yield is $1.20/$30= 4%). The marginal tax rate is 25%.
a. To maintain the current capital structure, how much of the new investment must be financed by common stock?
b. Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares, what is its WACC?
c. Assume there is not sufficient internal cash flow and the company must issue new shares. Qualitatively, what will happen to WACC? No calculations are required to answer this question.