Exam 9: The Cost of Capital

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?

Why should firms that own and operate multiple businesses that have different risk characteristics use business-specific,or divisional costs of capital?

Last year Gator Getters,Inc.had $50 million in total assets.Management desires to increase its plant and equipment during the coming year by $12 million.The company plans to finance 40 percent of the expansion with debt and the remaining 60 percent with equity capital.Bond financing will be at a 9 percent rate and will be sold at its par value.Common stock is currently selling for $50 per share,and flotation costs for new common stock will amount to $5 per share.The expected dividend next year for Gator is $2.50.Furthermore,dividends are expected to grow at a 6 percent rate far into the future.The marginal corporate tax rate is 34 percent.Internal funding available from additions to retained earnings is $4,000,000. a.What amount of new common stock must be sold if the existing capital structure is to be maintained? b.Calculate the weighted marginal cost of capital at an investment level of $12 million.

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?

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

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.

The cost of debt capital is obtained by substituting the net proceeds per bond for the bond price in the bond valuation equation and solving for the required return.

A company's capital structure mix is based on the proportion of fixed versus variable costs in its optimal production process.

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?

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

A firm's weighted average cost of capital is a function of (1)the individual costs of capital,(2)the capital structure mix,and (3)the level of financing necessary to make the investment.

Coyote Inc.operates three divisions.One division involves significant research and development,and thus has a high-risk cost of capital of 15%.The second division operates in business segments related to Coyote's core business,and this division has a cost of capital of 10% based upon its risk.Coyote's core business is the least risky segment,with a cost of capital of 8%.The firm's overall weighted average cost of capital of 11% has been used to evaluate capital budgeting projects for all three divisions.This approach will

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

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

Investors require higher rates of return to compensate for purchasing power losses resulting from inflation.

A firm's weighted average cost of capital is determined using all of the following inputs EXCEPT

In capital budgeting analysis,when computing the weighted average cost of capital,the CAPM approach is typically used to find which of the following?

Due to changes in regulatory requirements,the transactions costs associated with selling corporate securities increased by $1 per share.This change will

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

Corporations have two costs of common equity,one for retained earnings and one if the company issues new common stock.