Integrative case

The Hurrah Party Supply Company has compiled the following data relative to current costs and for various ranges of financing for its basic sources of external capital: long-term debt, preferred stock, and common stock equity.

Source of Capital After-tax Cost Range of Total New Financing
Long-term Debt 9% $ 0 - $800,000
10% $800,001 - $1,200,000
12% $1,200,001 and above
Preferred stock 21% $ 0 - $400,000
23% $400,001 and above
Common stock 22% $0 - $300,000
26% $300,001 - $650,000
28% $650,001 - $900,000
32% $900,001 and above

The firm expects to have $165,000 of current retained earnings in the coming year at a cost of 22%; once these retained earnings are exhausted, the firm will issue new common stock. The company's target capital structure proportions used in calculating the weighted average cost of capital are:

Source of Capital Target Capital Structure
Long-term debt 35%
Preferred stock 10%
Common stock equity 55%

a. Calculate the weighted average cost of capital for the firm prior to issuing new common stock.
b. Calculate the weighted average cost of capital for the firm once the retained earnings have been used up. (Use a total new financing requirement of $500,000.)
c. Given the following information on available investment opportunities, determine which projects should be selected and explain your choice.
Investment Initial Internal Rate
Opportunity Investment of Return
A 100,000 24%
B 100,000 23%
C 100,000 21%
D 100,000 19%
E 200,000 18%
F 300,000 18%