On January 1, the total market value of the Farrah

Fowler (FF) Company was $100 million. The firm’s present market value capital

structure, show below, is considered to be optimal. Assume that there is no

short-term debt

Debt = $30,000,000

Common Equity =

$70,000,000

Total capital =

$100,000,000

New bonds will have a

5.50 percent coupon rate and be sold at par (thus YTM = coupon rate). Common

stock is currently selling for $75 per share. Stockholders’ required rate of

return is estimated to be 12.0 percent consisting of a dividend yield of 5.0

percent and an expected growth rate of 7.0 percent. The marginal tax rate is

25.0 percent

a. What is the FF’s

market value capital structure? (2 points)

b. Assume that there is

sufficient cash flow such that FF can maintain its target capital structure

without issuing additional shares of equity. What is the WACC? (5 points)

C. Suppose now that

there is not enough internal cash flow and the firm must issue new shares of

stock. Qualitatively speaking (no computations required), what will happen to

the WACC (3 points