Exam 14: The Cost of Capital

What is the cost of common stock for Foggy Futures Weather Forecasters? The firm is in the 40% tax bracket. The optimal capital structure is listed below: ? S ource of Capital W eight Long-Term Debt 25\% Preferred Stock 20\% Common Stock 55\% ? \begin{array}{|l|l|}\hline \text { Debt: }&\begin{array}{ll}\text {The firm can issue \$ 1,000 \mathrm{p} ar value, \( 8 \% \) coupon interest bonds with a 20 -year }\\\text {maturity date. The bond has an average discount of \( \$ 30 \) and flotation costs of }\\\text { \( \$ 30 \) per bond. The selling price is \( \$ 1,000 \).}\end{array}\\\hline \text {Preferred Stock: }&\begin{array}{ll}\text {The firm can sell preferred stock with a dividend that is \( 8 \% \) of the current price. }\\\text { The stock costs \( \$ 95 \). The cost of issuing and selling the stock is expected }\\\text {to be \( \$ 5 \) per share. }\end{array}\\\hline \text {Common Stock: }&\begin{array}{ll}\text {The firm's common stock is currently selling for \( \$ 90 \) per share. }\\\text {The firm's common stock is currently selling for \( \$ 90 \) per share. The firm expects to pay cash dividends }\\\text { The dividends have been growing at \( 6 \% \). The stock must be discounted by \( \$ 7 \), }\\\text {and flotation costs are expected to amount to \( \$ 5 \) per share. }\end{array}\\\hline \text { Retained Earnings:}&\begin{array}{ll}\text { The firm expects to have enough retained earnings in the coming year to be used}\\\text { in place of any new stock being issued. }\end{array}\\\hline \end{array}

Haulsee Inc. pays no dividend currently but is expected to start paying a small dividend next year. The 5-year-old firm has a beta of 1.25 and current earnings of $0.90 per share. The current Treasury bill rate is 6.10%, and the market risk premium is 8.8%. Determine Haulsee's cost of equity if the firm's tax rate is 40%.

What is the cost of equity for East Roon if the firm is expected to always pay a constant dividend of $2.22? The firm's common stock is presently selling for $18.50.

Wright Express (WE) has a capital structure of 30% debt and 70% equity. WE is considering a project that requires an investment of $2.6 million. To finance this project, WE plans to issue 10-year bonds with a coupon interest rate of 12%. Each of these bonds has a $1,000 face value and will be sold to net WE $980. If the current risk-free rate is 7% and the expected market return is 14.5%, what is the weighted cost of capital for WE? Assume WE has a beta of 1.20 and a marginal tax rate of 40%.

Alpha Products maintains a capital structure of 40% debt and 60% common equity. To finance its capital budget for next year, the firm will sell $50 million of 11% debentures at par and finance the balance of its $125 million capital budget with retained earnings. Next year Alpha expects net income to grow 7% to $140 million, and dividends also are expected to increase 7% to $1.40 per share and to continue growing at that rate for the foreseeable future. The current market value of Alpha's stock is $30. If the firm has a marginal tax rate of 40%, what is its weighted cost of capital for the coming year?

For a company that is not planning to change its target capital structure, the proportions of debt and equity used in calculating the weighted cost of capital should be based on the current ____ value weights of the individual components.

Temple Company's common stock dividends have grown over the past 5-year period from $0.60 per share to $0.89 (today). Assume that Temple's dividends are expected to grow at this rate for the foreseeable future. Temple's stock is currently selling for $12 per share. New common stock can be sold to net the company $11 per share. Determine the costs of internal and external equity to Temple.

Heleveton Industries is 100% equity financed. Its current beta is 1.1. The expected market risk premium is 8.5%, and the risk-free rate is 4.2%. If Heleveton changes its capital structure to 25% debt, it estimates its beta will increase to 1.2. If the after-tax cost of debt will be 6%, should Heleveton make the capital structure change?

What is the cost of retained earnings for Foggy Futures Weather Forecasters? The firm is in the 40% tax bracket. The optimal capital structure is listed below: ? S ource of Capital W eight Long-Term Debt 25\% Preferred Stock 20\% Common Stock 55\% ? \begin{array}{|l|l|}\hline \text { Debt: }&\begin{array}{ll}\text {The firm can issue \$ 1,000 \mathrm{p} ar value, \( 8 \% \) coupon interest bonds with a 20 -year }\\\text {maturity date. The bond has an average discount of \( \$ 30 \) and flotation costs of }\\\text { \( \$ 30 \) per bond. The selling price is \( \$ 1,000 \).}\end{array}\\\hline \text {Preferred Stock: }&\begin{array}{ll}\text {The firm can sell preferred stock with a dividend that is \( 8 \% \) of the current price. }\\\text { The stock costs \( \$ 95 \). The cost of issuing and selling the stock is expected }\\\text {to be \( \$ 5 \) per share. }\end{array}\\\hline \text {Common Stock: }&\begin{array}{ll}\text {The firm's common stock is currently selling for \( \$ 90 \) per share. }\\\text {The firm's common stock is currently selling for \( \$ 90 \) per share. The firm expects to pay cash dividends }\\\text { The dividends have been growing at \( 6 \% \). The stock must be discounted by \( \$ 7 \), }\\\text {and flotation costs are expected to amount to \( \$ 5 \) per share. }\end{array}\\\hline \text { Retained Earnings:}&\begin{array}{ll}\text { The firm expects to have enough retained earnings in the coming year to be used}\\\text { in place of any new stock being issued. }\end{array}\\\hline \end{array}

The cost of depreciation-generated funds is equal to ____.

PDQ Inc. has a weighted cost of capital of 14.6% and has an opportunity to invest in the following average risk projects: Project Cost Annual Cost Flow Project life 1 \ 10,000 \ 1,992.43 10 years 2 \ 21,000 \ 4,526.84 8 years 3 \ 18,500 \ 4,580.34 7 years ? In which projects should PDQ invest? Assume no capital rationing.

The following financial information is available on Rawls Manufacturing Company: Current per share market price \ 48.00 Beta 1.1 Expected rate of return on market 12.0\% Risk-free rate 6.0\% ? Rawls can issue new common stock to net the company $44 per share. Determine the cost of internal equity capital using the capital asset pricing model approach. (Compute answer to the nearest 0.1%.)

A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will be ____ the marginal cost of capital for amounts over $700 million.

Depreciation does not generate cash. In what way, then, is depreciation a source of funds?

The historic beta of a firm is of little use as a forecast of the firm's future systematic risk characteristics when the firm is ____.

It is difficult for small firms to apply for the dividend valuation model because ____.

There are four major components that determine the risk premium. They include all of the following EXCEPT ____ risk.

Break points can be determined by dividing the amount of funds available from each financing source at a fixed cost by the ____ capital structure proportion for that financing source.

The cost of internal equity is cheaper than the cost of external equity. Which of the following statements is (are) correct? I. External equity may incur expenses that are deducted from the capital received for the sale of the Security. II. Corporations generally discount the price of the securities that are sold to the public in order to raise Capital.

Investors can form earnings growth expectations from various sources, including ____.