North Sea Oil has compiled the following data relative to current costs of its basic sources of external capitals, long-term debt, preferred stock, and common stock equiy.
Source of capital Cost
Long-Term Debt 7%
Preffered Stock 19%
Common Stock and Retained Earnings 20%
Below are the company’s target capital structure proportion used in calculating the weighted average cost of capital.
Source of Capital Target Capital Structure
Long Term Debt .25
Preferred Stock .25
Common Stock and Retained Earning .50
North Sea has the opportunity to invest in the following projects:
Project A Project B
Initial Investment $130,000 $85,000
Year Cash inflows Cash inflows
1 $25,000 $40,000
2 $35,000 $35000
3 $45,000 $30,000
4 $50,000 $10,000
5 $55,000 $5,000
Using the WACC to calculate the NPV and evaluate the IRR, which project should be implemented? (you may also wish to include payback to further support your answer).
Assuming the project(s) is implemented using equity financing, the capital structure changes to:
Source of Capital New capital structure after project implementation
Long term debt .20
Preferred stock .20
Common stock and retained earnings .60
Calculate the New WACC and briefly discuss in your report if this new WACC and capital structure might signal the market and investors
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