Question

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and Invest $25 million in new projects. The firm's present market value capital structure, shown below, is considered to be optimal. Assume that there is no short-term debt.

Debt $30.000.000
Common equity 30.000.000
Total capital $60.000.000

New bonds will have an 7% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders' required rate of return is estimated to be 12%, consisting
of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is $1.20, so $1.20/$30 = 4%.) The marginal corporate tax rate is 40%.

In order to maintain the present capital structure, how much of the new investment must be financed by common equity? Enter your answer in dollars. For example, $1.2 million should be entered as $1200000.
$_____

Answer 1

To maintain the 50/50 capital structure of the Tysseland Company while raising $25 million for new projects, $12.5 million must be financed through common equity.

Step-by-step explanation:

To determine how much of the new investment must be financed through common equity, we must maintain the firm's current capital structure. The Tysseland Company's present capital structure is evenly split between debt and common equity, with each accounting for $30 million of the total $60 million capital. Since the company is planning to raise and invest $25 million in new projects, this amount must be split according to the existing 50/50 structure.

The debt portion will thus be 50% of $25 million, which is $12.5 million. Since new bonds will be sold at a 7% coupon rate sold at par, this takes care of the debt portion. For the common equity portion, it also needs to be 50% of the new investment, which is another $12.5 million.

Therefore, to maintain the current capital structure, the company must finance $12.5 million of the investment through common equity.