Exam 9: The Cost of Capital

The capital asset pricing model uses three variables to evaluate required returns on common equity: the risk-free rate,the beta coefficient,and the market risk premium.

A reasonable estimate of the market risk premium based on historical data and expert opinion is between 5% and 7%.

All the following variables are used in computing the cost of debt EXCEPT

Flotation costs cause a corporation's cost of capital to be lower than its investors' required returns.

In general,which of the following rankings,from highest to lowest cost,is most accurate?

A corporate bond has a face value of $1,000 and a coupon rate of 9%.The bond matures in 14 years and has a current market price of $946.If the corporation sells more bonds,it will incur flotation costs of $26 per bond.If the corporate tax rate is 35%,what is the after-tax cost of debt capital?

A company is going to issue a $1,000 par value bond that pays a 7% annual coupon.The company expects investors to pay $942 for the 20-year bond.The expected flotation cost per bond is $42,and the firm is in the 34% tax bracket.Compute the following: a.the yield to maturity on the firm's bonds b.the firm's after-tax cost of existing debt c.the firm's after-tax cost of new debt

NewLinePhone Corp.is very risky,with a beta equal to 2.8 and a standard deviation of returns of 32%.The risk-free rate of return is 3% and the market risk premium is 8%.NewLinePhone's marginal tax rate is 35%.Use the capital asset pricing model to estimate NewLinePhone's cost of retained earnings.

Glenna Gayle common stock sells for $55,and dividends paid last year were $1.35.Flotation costs on issuing stock will be 8% of the market price.The dividends are predicted to have a 10% growth rate.What is the cost of internal equity,and new equity,respectively for Glenna Gayle?

GPS Inc.wishes to estimate its cost of retained earnings.The firm's beta is 1.3.The rate on 6-month T-bills is 2%,and the return on the S&P 500 index is 15%.What is the appropriate cost for retained earnings in determining the firm's cost of capital?

Crandal Dockworks is undergoing a major expansion.The expansion will be financed by issuing new 15-year,$1,000 par,9% annual coupon bonds.The market price of the bonds is $1,070 each.Five Rivers flotation expense on the new bonds will be $50 per bond.Crandal's marginal tax rate is 35%.What is the yield to maturity on the newly-issued bonds?

The firm's best financial structure is determined by finding the capital structure that minimizes the firm's cost of capital.

A security with a reasonably stable price will have a lower required rate of return than a security with an unstable price.

All else equal,an increase in beta results in

Haroldson Inc.common stock is selling for $22 per share.The last dividend was $1.20,and dividends are expected to grow at a 6% annual rate.Flotation costs on new stock sales are 5% of the selling price.What is the cost of Haroldson's retained earnings?

Given the following information on S & G Inc.'s capital structure,compute the company's weighted average cost of capital. The company's marginal tax rate is 40%.

In general,the least expensive source of capital is

Haroldson Inc.common stock is selling for $22 per share.The last dividend was $1.20,and dividends are expected to grow at a 6% annual rate.Flotation costs on new stock sales are 5% of the selling price.What is the cost of Haroldson Inc.'s new common stock?

PrimaCare has a capital structure that consists of $7 million of debt,$2 million of preferred stock,and $11 million of common equity,based upon current market values.The firm's yield to maturity on its bonds is 7.4%,and investors require an 8% return on the firm's preferred and a 14% return on PrimaCare's common stock.If the tax rate is 35%,what is PrimaCare's WACC?

The cost of debt increases relative to the investor's required return due to flotation costs,but decreases relative to the investor's required return due to the tax deductibility of interest.