Exam 9: The Cost of Capital

WineCellars Inc.currently has a weighted average cost of capital of 12%.WineCellars has been growing rapidly over the past several years,selling common stock in each year to finance its growth.However,due to difficult economic times this year,WineCellars decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold.WineCellars weighted average cost of capital this year should be

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

Gibson Industries is issuing a $1,000 par value bond with an 8% annual interest coupon rate that matures in 11 years.Investors are willing to pay $972,and flotation costs will be 9%.Gibson is in the 34% tax bracket.What will be the after-tax cost of new debt for the bond?

A corporation may lower its cost of capital by shifting a portion of its total financing from a higher cost source of capital,such as common equity,to a lower cost source of capital,such as debt.

The investor's required rate of return will equal the firm's cost of capital if corporate transactions costs are taken into account.

Using the weighted average cost of capital as the required rate of return for every project will

Toombes,Inc.is issuing new common stock at a market price of $55.Dividends last year were $3.30 per share and are expected to grow at a rate of 6%.Flotation costs will be 5% of the market price.What is Toombes' cost of retained earnings,and new equity,respectively?

Valley Flights,Inc.has a capital structure made up of 40% debt and 60% equity and a tax rate of 30%.A new issue of $1,000 par bonds maturing in 20 years can be issued with a coupon of 9% at a price of $1,098.18 with no flotation costs.The firm has no internal equity available for investment at this time,but can issue new common stock at a price of $45.The next expected dividend on the stock is $2.70.The dividend for the firm is expected to grow at a constant annual rate of 5% per year indefinitely.Flotation costs on new equity will be $7.00 per share.The company has the following independent investment projects available: Which of the above projects should the company take on?

TC,Inc.has $15 million of outstanding bonds with a coupon rate of 10 percent.The yield to maturity on these bonds is 12.5 percent.If the firm's tax rate is 30 percent,what is relevant cost of debt financing to Kendall,Inc.?

Sentry Manufacturing paid a dividend yesterday of $5 per share (D₀ = $4).The dividend is expected to grow at a constant rate of 8% per year.The price of Sentry Manufacturing's stock today is $29 per share.If Sentry Manufacturing decides to issue new common stock,flotation costs will equal $2.50 per share.Sentry Manufacturing's marginal tax rate is 35%.Based on the above information,the cost of retained earnings is

Tempo Corp.will issue preferred stock to finance a new artillery line.The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share.Investment bankers have advised Tempo that flotation costs on the new preferred issue would be 5% of the selling price.Tempo's marginal tax rate is 30%.What is the relevant cost of new preferred stock?

The DEF Company is planning a $64 million expansion.The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock.The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent.If the company is in the 35 percent tax bracket,what is the firm's cost of capital?

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

Office Clean Corporation has a capital structure consisting of 30 percent debt and 70 percent common equity.Assuming the capital structure is optimal,what amount of total investment can be financed by a $35 million addition to retained earnings without selling new common stock?

A corporate bond has a face value of $1,000 and a coupon rate of 5%.The bond matures in 15 years and has a current market price of $925.If the corporation sells more bonds it will incur flotation costs of $25 per bond.If the corporate tax rate is 35%,what is the after-tax cost of debt capital?

A company's cost of capital is equal to a weighted average of its investors' required returns.

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 a firm's tax rate increases then its weighted average cost of capital increases also.

The cost of internal common equity is already on an after-tax basis since dividends paid to common stockholders are not tax deductible.

The cost of retained earnings is less than the cost of new common stock because