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current capital structure proportions of 25% long-term debt, 10%
preferred stock, and 65% common stock equity for at least the next 3
years. In addition, it plans to continue paying out 40% of its earnings
as dividends. Total capital expenditures are yet to be determined.
Jennings has been presented with several competing investment
opportunities by division and product managers. However, because
funds are limited, choices of which projects to accept must be made.
A list of investment opportunities is shown in Table 2. To analyze the
effect of the increased financing requirements on the weighted
average cost of capital (WACC), Jennings contacted a leading
investment banking firm that provided the financing cost data given in
Table 3. O’Grady is in the 40% tax bracket.
TABLE 1
Selected Income Statement Items

TABLE 2
TABLE 3

Financing Cost Data

Long-term debt: The firm can raise $700,000 of additional debt by
selling 10-year, $1,000, 12% annual interest rate bonds to net $970
after flotation costs. Any debt in excess of $700,000 will have a
before-tax cost, rd, of 18%.
Preferred stock: Preferred stock, regardless of the amount sold, can
be issued with a $60 par value and a 17% annual dividend rate. It will
net $57 per share after flotation costs.
Common stock equity: The firm expects its dividends and earnings
to continue to grow at a constant rate of 15% per year. The firm’s
stock is currently selling for $20 per share. The firm expects to have
$1,300,000 of available retained earnings. Once the retained earnings
have been exhausted, the firm can raise additional funds by selling