Exam 10: Determining the Cost of Capital

Dobson Dairies has a capital structure which consists of 60 percent long-term debt and 40 percent common stock. The company's CFO has obtained the following information: • The before-tax yield to maturity on the company's bonds is 8 percent. • The company's common stock is expected to pay a $3.00 dividend at year end (D1 = $3.00)• Assume the firm will be able to use retained earnings to fund the equity portion of its capital budget. • The company's tax rate is 40 percent. What is the company's weighted average cost of capital (WACC)?

Johnson Industries finances its projects with 40 percent debt, 10 percent preferred stock, and 50 percent common stock. • The company can issue bonds at a yield to maturity of 8.4 percent. • The cost of preferred stock is 9 percent. • The company's common stock currently sells for $30 a share. • The company's dividend is currently $2.00 a share (D0 = $2.00)• Assume that the flotation cost on debt and preferred stock is zero, and no new stock will be issued. • The company's tax rate is 30 percent. What is the company's weighted average cost of capital (WACC)?

What is the firm's cost of common stock (rs) using the DCF approach?

Firms should use their weighted average cost of capital (WACC) when they are funding their capital projects with a variety of sources. However, when the firm plans on using only debt or only equity to fund a particular project, it should use the after-tax cost of the specific source of capital to evaluate that project.

Since 70 percent of preferred dividends received by a corporation is excluded from taxable income, the component cost of equity for a company which pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be Cost of equity = rs(0.30)(0.50) + rps(1 - T)(0.70)(0.50).

Your company's stock sells for $50 per share, its last dividend (D0) was $2.00, and its growth rate is a constant 5 percent. What is the cost of common stock, rs?

A company has determined that its optimal capital structure consists of 40 percent debt and 60 percent equity. Given the following information, calculate the firm's weighted average cost of capital. rd = 6% Tax rate = 40% P0 = $25 Growth = 0% D0 = $2.00

Which of the following is not considered a capital component?

What is Rollins' cost of common stock using the bond-yield-plus-risk-premium approach?

The component costs of capital are market-determined variables in as much as they are based on investors' required returns.

Which of the following statements is most correct?

Which of the following statements is most correct?

J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. The firm's current after tax cost of debt is 6 percent, and it can sell as much debt as it wishes at this rate. The firm's preferred stock currently sells for $90 per share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. Ross's common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. -What is the firm's cost of newly issued preferred stock, rps?

Which of the following statements about the cost of capital is incorrect?

Which of the following statements is most correct?

Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's marginal tax rate is 40 percent. -What is Rollins' cost of common stock (rs) using the CAPM approach?

Which of the following methods of estimating the cost of common equity for a firm treats risk explicitly?

Which of the following statements is most correct?

A firm going from a lower to a higher tax bracket could increase its use of debt, yet actually wind up with a lower after-tax cost of debt.

Allison Engines Corporation has established a target capital structure of 40 percent debt and 60 percent common equity. The firm expects to earn $600 in after-tax income during the coming year, and it will retain 40 percent of those earnings. The current market price of the firm's stock is P0 = $28; its last dividend was D0 = $2.20, and its expected growth rate is 6 percent. Allison can issue new common stock at a 15 percent flotation cost. What will Allison's marginal cost of equity capital (not the WACC) be if it must fund a capital budget requiring $600 in total new capital?