Exam 9: The Cost of Capital

Cost of capital is commonly used interchangeably with all of the following terms EXCEPT

The Capital Asset Pricing Model may be used to estimate the cost of retained earnings.

Preferred dividends are paid with before-tax dollars because the dividend rate is known,whereas common stock dividends are paid with after-tax dollars.

Using the weighted cost of capital as a cutoff rate assumes that future investments will be financed so as to maintain the firm's target degree of financial leverage.

If the before-tax cost of debt is 7% and the firm has a 40% marginal tax rate,the after-tax cost of debt is 2.8%.

The market value weights are preferred when calculating a firm's weighted average cost of capital.

Which of the following should NOT be considered when calculating a firm's WACC?

New Jet Airlines plans to issue 14-year bonds with a par value of $1,000 that will pay $60 every six months.The bonds have a market price of $1,220.Flotation costs on new debt will be 4% of the selling price.If the firm has a 35% marginal tax bracket,compute the following: a.Yield to maturity of debt b.After-tax cost of existing debt c.After-tax cost of new debt

The best financial structure is determined by finding the debt and equity mix that maximizes the firm's cost of capital.

GHJ Inc.is investing in a major capital budgeting project that will require the expenditure of $16 million.The money will be raised by issuing $2 million of bonds,$4 million of preferred stock,and $10 million of new common stock.The company estimates is after-tax cost of debt to be 7%,its cost of preferred stock to be 9%,the cost of retained earnings to be 14%,and the cost of new common stock to be 17%.What is the weighted average cost of capital for this project?

Other things equal,management should retain profits only if the company's investments within the firm are at least as attractive as the stockholders' other investment opportunities.

JPR Company is financed 75 percent by equity and 25 percent by debt.If the firm expects to earn $30 million in net income next year and retain 40% of it,how large can the capital budget be before common stock must be sold?

Sutter Corporation's common stock is selling for $16.80 a share.Last year Sutter paid a dividend of $.80.Investors are expecting Sutter's dividends to grow at an annual rate of 5% per year.What is the cost of internal equity?

The risk-free rate of return is 3% and the expected return on the market portfolio is 14%.Oklahoma Oilco has a beta of 2.0 and a standard deviation of returns of 26%.Oilco's marginal tax rate is 35%.Analysts expect Oilco's net income to grow by 12% per year for the next 5 years.Using the capital asset pricing model,what is Oklahoma Oilco's cost of retained earnings?

The cost of external equity capital is greater than the cost of retained earnings because of

XRT,Inc.is issuing a $1,000 par value bond that pays 8.5% interest annually.Investors are expected to pay $1,100 for the 12-year bond.The firm will pay $50 per bond in flotation costs.What is the after-tax cost of new debt if the firm is in the 35% tax bracket?

The firm financed completely with equity capital has a cost of capital equal to the required return on common stock.

The cost of preferred stock is equal to the preferred stock dividend divided by the net proceeds per preferred share.

Cost of capital is

The common stock for El Viss Company currently sells for $20 per share.The firm just paid a dividend of $1.50,and the dividend three years ago was $1.30.Dividends per share are anticipated to grow at the same rate in the future as they have over the past three years.Flotation costs for new shares will be 6% of the selling price.Calculate the following: a.the cost of retained earnings b.the cost of external equity capital