Case Study-Eco Plastics Company
Since Its Inception, Echo Plastics Company has been revolutionize plastic and trying to do its part to save the environment. Echo’s founder, Marion Cowboys, developed a biodegradable plastic that her company is marketing to manufacturing companies throughout the southeastern united States. After operating as a private company for six years, Echo went public in 2009 and is listed on the Nasdaq stock exchange. As the chief financial officer of a young company with lots of investment opportunities, Echo’s
SCOFF closely monitors the firm’s cost of capital.
The SCOFF keeps tabs on each of the individual costs of Seeds three main financing sources: long-term debt, preferred stock, and common stock. The target capital structure for ECHO is given by the weights in the following table: Source of capital Weight Long-term debt ? Preferred stock ? 20 Common stock equity 50 Total ћ 100% At the present time, Echo can raise debt by selling 20-year bonds with a $1 ,OHO par value and a 10. 5% annual coupon interest rate.
Echo’s corporate tax rate is 40%, and TTS bonds generally require an average discount of $45 per bond and flotation costs of $32 per bond when being sold. Chefs outstanding preferred stock pays a 9% dividend and has a $95-per-share par value.
The cost of Issuing and selling additional preferred stock Is expected to be $7 per share. Because Echo Is a young firm that requires lots of cash to grow it does not currently pay a dividend to common stock holders. To track the cost of common stock the SCOFF uses the capital asset pricing model (CAMP).
The SCOFF and the firm’s investment advisors believe that the appropriate risk-free rate is 4% and that the market’s expected return equals 13%. Using data from 2009 through 201 2, Echo’s SCOFF estimates the firm’s beta to be 1. 3.
Although Echo’s current target capital structure Includes 20% preferred stock, the company Is considering using debt financing to retire the outstanding preferred stock, thus shifting their target capital structure to 50% long-term debt and 50% common stock. If Echo shifts its capital mix from preferred stock to debt, its financial advisors expect its beta to increase