The following data applies to Crunch Cookie Company:

 

Income Statement

Sales: $1,000,000

Operating Expenses: (626,000)

EBIT: 374,000

Interest: (24,000)

EBT: 350,000

Taxes @40%: (140,000)

Net Income: 210,000

 

Year       Net Income        Per Share

1988       $210,000              3.50

1987       195,000                3.25

1986       180,000                3.00

1985       167,000                2.75

1984       155,000                2.60

1983       143,500                2.40

1982       132,500                2.20

 

Assets

Current $300,000

Fixed $600,000

Total $900,000

 

Liabilities and Owners’ Equity

Bonds ($1000 par) $300,000

Common Stock ($20par) $300,000

Retained Earnings $300,000

Total $900,000

 

Bond Price $687                Common Stock Price $54

 

Common Stock costs $5 per share to issue, floatation cost for bonds is 5% and the bonds have ten years to maturity. Assume the growth rate in earnings and dividends to be constant over time and the payout rate to be the same as in the previous year.

A.      What is the expected earnings and expected retained earnings for 1989?

B.      What is Crunch’s weighted average cost of capital with retained earnings? Without retained earnings?

C.      At what level of total financing will the WACC increase?

D.      In order to estimate the weighted average cost of capital we need to make certain assumptions. What are these assumptions and explain why we need to make them.