Question:

At what debt percentage to fund $ 1 5 millions for the project WACC will be lowestIn March 2023, the management team of Londonderry Air (LA) met to discuss a proposal to purchase five shorthaul aircraft ata total cost of $25 million. There was general enthusiasm for the investment, and the new aircraft were expected to generate an annual cash flow of $4 million for 20 years. ‘The focus of the meeting was on how to finance the purchase. LA had $20 million in cash and marketable securities (se table). but Ed Johnson, the chief financial officer, pointed out that the company needed at least $10 million in cash to meet normal outflow and as a contingency reserve. This meant that there would be a cash deficiency of $15. million, which the firm would need to cover either by the sale of common stock or by additional borrowing. While admitting that the arguments were finely balanced, Mr. Johnson recommended an issue of stock. He pointed out that the airline industry was subject to wide swings in profits and the firm should be careful to avoid the risk of excessive borrowing. He estimated that in market value terms, the long-term debt ratio was about 59% and that a further debt issue would raise the ratio to 62%. Mr. Johnson's only doubt about making a stock issue was that investors might jump to the conclusion that management believed the stock was overpriced, in which case the announcement might prompt an unjustified selloff by investors. He stressed. therefore, that the company needed to explain carefully the reasons for the issue. Also, he suggested that demand for the issue would be enhanced if at the same time LA increased its dividend payment. This would provide a tangible indication of management's confidence in the future. Summary financial statements for Londot (Figures are book values, in millions of dc BALANCE SHEET Bank debt $50 Cash Other current 20 Other cu liabilities assets 10% bond, due 2037" 100 Fixed asc Stockholders’ equity’ 120 Total liabilities $290 Total ass: INCOME STATEMENT Comer matt = Mr. Johnson's only doubt about making a stock issue was that investors might jump to the conclusion that management believed the stock was overpriced, in which case the announcement might prompt an unjustified selloff by investors. He stressed. therefore, that the company needed to explain carefully the reasons for the issue. Also, he suggested that demand for the issue would be enhanced if at the same time LA increased its dividend payment. This would provide a tangible indication of management's confidence in the future. statements for Londonderry Air, 2022 salues, in millions of dollars) BALANCE SHEET $50 Cash $20 20 Other current 20 assets 37° 100 Fixed assets 250 ty 120 — $290 Total assets $290 = 10% bond, due 2037" 100 Fixed ase Stockholders’ equity” 120 Total liabilities $290 Total ass: INCOME STATEMENT Gross profit $575 Depreciation 200 Interest 75 Pretax profit 300 Tax 105 Net profit 195 Dividend 65 “The ied to matuty on LA deb curenty is 6% La has 10 millon shares outstanding, ith a market price of betas estimated at 125, the marke isk premium s 8%, and These arguments cut little ice with Paes 500 LA's chief executive. “Ed.” she said, — “I know that you're the expert on all this, but everything you say flies in the face of common sense. Why should we want to sell ‘more equity when our stock has fallen over the past year by nearly a fifth? Our stock is currently offering a dividend yield of 6.5%, which makes equity an expensive source of capital. Increasing the dividend would simply “The yield to matty on LA deb curenty fs 6% LA has 10 millon shares outstanding with a market price of beta i estimated at 125, the market rik premium fs 8%, nd ‘These arguments cut little ice with page 500 LA's chief executive. “Ed,” she said, “I know that you're the expert on all this, but everything you say flies in the face of common sense. Why should we want to sell more equity when our stock has fallen over the past year by nearly a fifth? Our stock is currently offering a dividend yield of 6.5%, which makes equity an expensive source of capital. Increasing the dividend would simply make it more expensive. What's more, I don't see the point of paying out more money to the stockholders at the same time that we are asking rhem for cash. If we hike the dividend, we will need to increase the amount of the stock issue; so we will just be paying the higher dividend out of the shareholders’ own pockets. You're also ignoring the question of dilution. Our equity currently has a book value of $12 a share; it's not playing fair by our existing shareholders if we now issue stock for around $10 a share. “Look at the alternative. We can borrow today at 6%. We get a tax break on the