Eco Plastic Solution Essay

This case focuses on determination of the address of capital for a firm. The student determines the cost of individual sources of financing, including long-term debt, preferred neckcloth, and communal stock. The cost of debt is adjusted for Eco Plastics 40% tax bracket. The company is considering a new fiscal structure, with the replacement of preferred stock financing with debt financing. Additional use of debt increases the common stockholders required rate of return. The student is asked to compare the two weighted median(a) costs of capital and identify the better financial structure for Eco Plastics Company.a. constitute of debtProceeds from sale of $1,000 par value bond$1,000 (average discount & flotation costs)$1,000 ($45 + $32) = $923Subsequent payments Interest payments ($1,000 0.105) + Par valueBefore-tax cost of debtN = 20, PV = $923, PMT = 105, FV = 1,000Solve for I = 11.50%After-tax cost of debt ri = rd (1-T) = 11.5% (10.4) = 6.9%b. Cost of preferred stock rp = Dp Np= (0.095 $95) ($95 $7)= $9.02 $88= 10.25%c. Cost of common stock rj = RF + bj (rm RF)= 0.04 + 1.3 (0.13 0.04)= 0.04 + 1.3 0.09= 0.04 + 0.1170= 15.7%d. Weighted average cost of capital ra = (wi ri) + (wp rp) + (ws rn)= (0.30 0.069) + (0.20 0.1025) + (0.50 0.157)= 0.0207 + 0.0205 + 0.785= 0.1197, or rough 12%e. 1. Change in risk Premium Change in beta market risk premium = (1.5 1.3) (0.13 0.04)= 0.2 0.09 = 0.018Shareholders require 1.8% more per social classNew cost of common equity rj = RF + bj (rm RF)= 0.04 + 1.5 (0.13 0.04)= 0.04 + 1.5 0.09= 0.04 + 0.1350= 17.5%Note 17.5% 15.7% = 1.8%2. rewrite weighted average cost of capital ra= (wi x ri) + (ws x rn) = (0.50 0.069) + (0.50 0.175)= 0.0345 + 0.0875= 0.12203. Eco Plastics CFO should retain the cheaper current financial structure. Replacing preferred stock financing with debt financing results in more risk to the stockholders. The increase in stockholders required rate of return is more than offse ts the advantage of using the beginning cost debt. If Eco Plastics CFO were to revise the capital structure, share price would diminution and shareholder wealth would not be maximized.