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Problem #1 (19 Marks) Phrazle Inc. considering expending into Eastern Canada. This project is in the same line of business as the firm's current operations and is therefore not expected to alter the risk of the firm. The most recent balance sheet is provided below. Notes to financial statements: * The 6.5% semi-annual coupon bonds have a face value of $1,000, were issued 3 years ago and have 12 years to maturity. The bonds are currently selling for a quoted price of 96.5. The preferred shares have a $50 par value and 4% dividend and are currently selling for $23.53 per share. ***There are 750,000 common shares outstanding that are currently selling for $$3.50 per share. The CFO has gathered the information below to determine whether the project should be accepted. - The marginal tax rate =35% - The most recent dividend paid was $1.75. Dividends grew at a rate of 5% per year for the last 4 years and are expected to grow at a constant rate =7%, forever. a) Calculate Phrazle's before- tax cost of debt. (6 marks) b) Calculate Phrazle's cost of preferred shares. (2 marks) c) Calculate Phrazle's cost of common equity using the Dividend Discount Model. (3 marks) d) Calculate the capital structure weights, based on market values. (5 marks) e) Calculate the discount rate that should be used to evaluate the expansion into Eastern Canada. (2 marks) f) If the expansion into Eastern Canada has an Internal Rate of Return (IRR) =10%, what would you recommend to the CFO? Explain. (1 mark)

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