Part A

After-TAX Cost Debt

O’Grandy Apparel Company can calculate the after tax debt cost using YTM (CP + (FV-Nd /n) / FV +Nd /2) *2. Cp is (0.12/2) * 1000= 60 Semi-annually Fv is 1000 Nd is 995 – (0.025* 1000) = 970

N is 20*2 because it is semi-annually then you have to use Kdt= Kd+ (i-T) .The tax bracket is 40 percent. Now we can have the after tax debt when it is equal or smaller than $700000

Kd ( 1-T) = 0.1249 (1-0.4)= 0.07494. If it is more than $700000 it will be KD (1-t) = 0.18(1-0.4) = 0.108

The Cost of Preferred Equity

If o’grady Apparel Company wants to raise financing using preferred shares, it could use Po = D/K KPS=D/Pn . so, 17% annual dividend rate times $60 (stated value) which is Dt is 10.2. After that 10.2
*…show more content…*

The company’s overall cost of capital is 19.83%. The firm will raise $3,300,000 and the overall cost of these funds will be 19.83%. The company will proceed with projects A, C, D and which require total investments of $3,300,000. All projects are expected to provide a return greater than the cost of financing. As a result all providers of financing will receive their required returns.

Part D

The O’Grady Apparel Company wanted to see the effects of a more highly levered capital structure on their ability to take on potential investments. The break points for this highly levered capital structure consisting of 50 percent long-term debt, 10 percent preferred equity, and 40 percent common equity are calculated in very much the same way as the break points from part B involving the original capital structure. The only difference between the two calculations is that the reinvested profits of 1,300,000 and the $700,000 in additional debt were calculated over the new structure values. The resulting breakpoints are $3,250,000 for common equity and $1,400,000 for long-term debt (see exhibit 4a).

The highly levered capital structure had a significant effect on the findings of sections B and C. First of all, the ranges which resulted from the new calculation of the break points caused the weighted average cost of capital (WACC) at all range levels to drop. The WACC is calculated by multiplying the weights of the capital structure by the costs of

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