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Ezzell Enterprises has the following capital structure, which it considers to be optimal under present and forecasted conditions:
Debt (long-term only) 45%
Common equity 55
Total liabilities and equity 100%
For the coming year, management expects after-tax earnings of $2.5 million. Ezzell’s past dividend policy of paying out 60 percent of earnings will continue. Present commitments from its banker will allow Ezzell to borrow according to the following schedule:
Loan Amount Interest Rate
$ 1 to $500,000 9% on this increment of debt
$500,001 to $900,000 11% on this increment of debt
$900,001 and above 13% on this increment of debt
The company’s marginal tax rate is 40 percent, the current market price of its stock is $22 per share, its lastdividend was $2.20 per share, and the expected growth rate is 5 percent. External equity (new common) can be sold at a flotation cost of 10 percent.
Ezzell has the following independent investment opportunities for the next year:
Project Cost IRR
1 $675,000 16.0%
2 900,000 15.0
3 375,000 14.0
4 562,500 12.5
5 750,000 11.0
Management asks you to help determine which projects (if any) should be undertaken. You proceed with this analysis by answering the following questions (or performing the tasks) as posed in a logical sequence:
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