Exam 14: The Cost of Capital

What is the cost of debt 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}

Mid-States Utility Company just issued a $3.20 cumulative preferred stock at a price to the public of $30 a share. The flotation costs were $1.50 a share, and the issue will be retired in 20 years at its $30 par value. What is the cost of this preferred issue?

How is the marginal cost of the various component capital sources determined?

Determine the weighted cost of capital for the Mills Company that will finance its optimal capital budget with $120 million of long-term debt (k_d = 12.5%) and $180 million in retained earnings (k_e = 16.0%). Mills' present capital structure is considered optimal. The company's marginal tax rate is 40%. (Compute answer to nearest 0.1%.)

Weltron has a target capital structure of 35% debt and 65% equity. If the firm expects net income of $12.3 million and an annual dividend of $0.12 per share, what is the expected equity break point? There are 12 million shares outstanding.

The optimal capital budget is determined by comparing the expected project returns to the company's ____.

Mid-South Utilities will sell $10 million of $100 par value preferred stock that will pay an annual dividend of $9.75. Mid-South will receive $93.98 per share after flotation costs. If the issue must be retired in 20 years, what is the cost of the preferred issue?

The cost of internal common equity is represented in financial formulas as ____.

Whipple Industries Inc. is in the process of determining its optimal capital budget for next year. The following investment projects are under consideration: Required Expected Rate Project Investment of Retum A \ 2 million 20.0\% \ 3 million 15.0\% \ 1 million 13.5\% \ 4 million 13.0\% \ 1 million 12.5\% \ 3 million 12.0\% \ 5 million 11.5\% ? The firm's marginal cost of capital schedule is as follows: Amount of Funds Raised Cost \ 0-\ 6 million 12.0\% \ 6 million - \ 12 million 12.5\% \ 12 million -\ 18 million 13.5\% Over \ 18 million 15.0\% ? Determine Whipple's optimal capital budget (in dollars) for the coming year.

The cost of equity capital for non-dividend paying stocks can be determined by ____. I. using the Capital Asset Pricing Model II. estimating k_e for comparable dividend-paying stocks in their industry

Calculate the after-tax cost of preferred stock for Ohio Valley Power Company, which is planning to sell $100 million of $3.25 cumulative preferred stock to the public at a price of $25 per share. Flotation costs are $1.00 per share. Ohio Valley has a marginal income tax rate of 40%.

If a firm sells assets, generating cash flows, the cost of these funds is ____.

The cost of external equity is greater than the cost of internal equity because ____.

Using rounded whole percents for the various costs and weighted costs, what is the weighted average cost of capital 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}

GQ earned $740,000 before taxes this year. The firm has a debt ratio of 30%, a marginal tax rate of 35%, and a dividend payout ratio of 40%. GQ has no preferred stock. What is GQ's break point for equity?

If a firm adopts a large proportion of above-average-risk investment projects that are not offset by below-average-risk investment projects, ____.

The constant growth valuation model approach to calculating the cost of equity assumes that ____.

Far Out Tech (FOT) has a debt ratio of 0.3, and it considers this to be its optimal capital structure. FOT has no preferred stock. FOT has analyzed four capital projects for the coming year as follows: Project Net Investment IRR 1 \ 3,000,000 13.5\% 2 \ 1,500,000 18.0\% 3 \ 2,000,000 12.6\% 4 \ 1,600,000 16.0\% ? FOT expects to earn $2.7 million after tax next year and pay out $700,000 in dividends. Dividends are expected to be $1.05 a share during the coming year and are expected to grow at a constant rate of 10% a year for the foreseeable future. The current market price of FOT stock is $22 and up to $2 million in new equity can be raised for a flotation cost of 10%. If more than $2 million is sold then the flotation cost will be 15%. Up to $2 million in debt can be sold at par with a coupon rate of 10%. Any debt over $2 million will carry a 12% coupon rate and be sold at par. If FOT has a marginal tax rate of 40%, in which projects should it invest?

Which of the following statements regarding the cost of capital is (are) correct? I. The weighted cost of capital is the discount rate used when computing the net present value. II. The after-tax cost of capital is weighted by the proportions of the capital components in the firm's long-range target capital structure.

The required rate of return on any security consists of a(n) ____.