# The cost of common stock

Table of Content

Students are required to form a group of THREE TO FOUR (3-4) members and register their grouping with their respective class representative (CR) by Week 2. Lecturer’s approval must be obtained if there is any change in the number of students due to withdrawal from the course. The deadline for written assignment submission is set in Week 11 on the 17 November 2013 during the class hour.

CASE STUDY:

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Integrative Case 1: Eco Plastics Company

Since its inception, Eco Plastics Company has been revolutionizing plastic 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 six years, Eco went public in 2009 and is listed on the Nasdaq Stock Exchange. As the chief financial officer of a young company with lots of investment opportunities, Eco’s CFO closely monitor the firm’s 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 for Eco is given by the weights in the following table:

Source of capitalWeight
Long-term debt30%
Preferred stock20%
Common stock equity50%
Total100%
At the present time, Eco can raise debt by selling 20-year bonds with a \$1,000 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 and floatation costs of \$32 per bond when being sold. Eco’s outstanding preferred stocks 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 common stock holders. To track the cost of common stock the CFO uses the capital asset pricing model (CAPM). The CFO and the firm’s investment advisors believe that the appropriate risk-free rate is 4% and that market’s expected return equals 13%. Using data from 2009 through 2012, Eco’s CFO estimates the firm’s beta to be 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 debt and 50% common stock. If Eco shifts its capital capital mix from preferred stock to debt, its financial advisors expect its beta to increase to 1.5. Tasks to do:

(a) Calculate Eco’s current after-tax cost of long-term debt (b) Calculate Eco’s current cost of preferred stock
(c) Calculate Eco’s current cost of common stock
(d) Calculate Eco’s current weighted average cost of capital (e) i. Assuming that the debt financing costs do not change, what effect would a shift to a 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? ii. What would be Eco’s new weighted average cost of capital? iii. Which capital structure-the original one or this one – seems better? Why?

REQUIREMENTS:

To be acceptable, your paper must

1.be 4 to 5 pages in length, and must be typed, 1.5-spaced, and have 11-point Arial font.

2.be submitted on the date due.

3.be stapled in the upper left hand corner; do not use a plastic report cover. 4.have a cover sheet or title page with your name in the upper right hand corner, the title of your paper approximately centered on the page and toward the bottom of the page the name of the subject, my name and the date the paper is submitted.

The written assignment is worth 30 points.

Organization: Introduction, Conclusion, Logical Flow, Layout, Sentencing

In your paper, the main thing is to make your point as quickly and concisely as possible and this means in the first paragraph, followed by your critical discussions and arguments. The last paragraph is the proper place to restate the main point and to spell out in a little more detail about your paper. A very important element in grading written paper is whether or not the paper has a clear focus and is clearly structured. Clear focus requires your paper to concentrate on the important or most arguable points.

Clarity of structure means that parts of your written paper fit together in a logical fashion. You should use cause-and-effect connections as much as possible, to relate sentences and to link paragraphs. Papers that are classified by short and choppy sentences fall into the lowest grade; papers which spend an excessive amount of time on simply describing events or presenting information rather than critically discuss the issue are unlikely to make it into the highest grade.

Pay particular attention to grammar and spelling when writing your paper. Marks will be deducted if the paper contains •Misspelled proper names
•Seriously misused common words: “there” for “their”, “to” for “too” •Excessive informality of style (avoid the use of “you” and slang)
•Failure of subject-verb agreement or mixing tenses
•Sentence fragments (sentences without a verb or subject) •Run-on sentences (sentences which are connected together with commas when they should be separated by a period or term such as “because” , “although” and others)

Ideas: Problem Statement, Evidence of Support, Provision of Examples, Presentation of argument

Problem statement:
Addressed the issues specified and demonstrate a thorough understanding

Evidence of support:
Integrates the issues discussed with relevant details

Provision of examples:
Able to illustrate the concept discussed with relevant examples

Presentation of argument:
Able to fully synthesize the material discussed and critically argue the issues.

Referencing