Eco Plastic Solution Essay

This case focuses on determination of the woo of capital for a firm. The student determines the comprise of individual sources of financial support, including long-term debt, prefer stock, and putting green stock. The cost of debt is adjusted for Eco Plastics 40% tax bracket. The company is considering a new financial 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 cardinal weighted average costs of capital and identify the better financial structure for Eco Plastics Company.a. Cost of debt regaining from sale of $1,000 par value bond$1,000 (average discount & floatation costs)$1,000 ($45 + $32) = $923Subsequent payments Interest payments ($1,000 0.105) + score 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 about 12%e. 1. counterchange 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% to a greater extent per yearNew 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. Revised 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 r eturn is more than offsets the advantage of using the low cost debt. If Eco Plastics CFO were to revise the capital structure, share price would decline in quality and shareholder wealth would not be maximized.