Home / Questions / Nealon Energy Corp constructing a natural gas gathering center estimated cost of $70 milli...
Nealon Energy Corp. constructing a natural gas gathering center estimated cost of $70 million. To finance, Nealon has $20 million in profits to finance a portion of teh expansion and plans to sell a bond issue to raise the remaining $50 million.The following balance sheet reflects the mix of capital sources that Nealon has used in the past.
Source of Financing Target Capital Structure Weights
Bonds 40%
Common Stock 60%
The firm currently has one issue of bonds coutstanding. The bonds have a par value of $1000 per bond, carry an 8% coupoun rate of interest, 16 years to maturity, and sellin for $1,035. Common stock current market price of $35 and paid a $2.50 dividned lasy year that is expected to increase at an annual rate of 6%.
a. What is the yield to maturity for Nealon's bonds under current market conditions?
b. Waht is the cost of new debt financing to Nealon based on current market prices after both taxes (34% marginal tax rate) and floatation costs of $30 per bond?
c. What is the investor's required rate of return for Nelaon's common stock? If Nealon were to sell new shares of common stock it would incur a cost of $2.00per share. What is your estimate of the cost of new equity financing raised from the sale of common stock?
d. Compute the weighted average cost of capital for Nealon's investment unsing the weighs reflected in the actual financing mix (that is $20 mil in retained earnings and $50 mil in bonds).
e. Compute the weughted average cost of capital for Nealon where the firm maintains its target capital structure by reducing debt offering to 40% of teh $70 mil in new capital, or $28 mil using $20 mil in retained earnings and raisng $22 mil througha new equity offering
f. If you were the CFO for the company, would you prefer to use the calculation cost of capital in part (d) or (e) to evaluate the new project? Why?
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