Exam 9: The Cost of Capital

The cost of capital is the rate that must be earned on an investment project if the project is to increase the value of the common shareholders' investment.

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.

Donner,Inc.will finance a proposed investment by issuing new securities while maintaining its optimal capital structure of 60% debt and 40% equity.The firm can issue bonds at a price of $950.00 before $15 flotation costs.The 10-year bonds will have an annual coupon rate of 8% and a face value of $1,000.The company can issue new equity at a before-tax cost of 16% and its marginal tax rate is 34%.What is the appropriate cost of capital to use in analyzing this project?

Grandview Inc.will issue new common stock to finance an expansion.The existing common stock just paid a $1.50 dividend,and dividends are expected to grow at a constant rate 8% indefinitely.The stock sells for $45,and flotation expenses of 5% of the selling price will be incurred on new shares.What is the cost of retained earnings for Grandview?

Cost of capital is

Blammo,Inc.has a target capital structure of 30% debt and 70% equity.The firm is planning to invest in a project that will necessitate raising new capital.New debt will be issued at a before-tax yield of 14%,with a coupon rate of 10%.The equity will be provided by internally generated funds so no new outside equity will be issued.If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%,compute the firm's cost of capital.

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

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?

Meacham Corp.wants to issue bonds with a 9% coupon rate,a face value of $1,000,and 12 years to maturity.Meacham estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per bond.Meacham Corp.common stock currently sells for $30 per share.Meacham can sell additional shares by incurring flotation costs of $3 per share.Meacham paid a dividend yesterday of $4.00 per share and expects the dividend to grow at a constant rate of 5% per year.Meacham also expects to have $12 million of retained earnings available for use in capital budgeting projects during the coming year.Meacham's capital structure is 40% debt and 60% common equity.Meacham's marginal tax rate is 35%. a.Calculate the after-tax cost of debt assuming Meacham's bonds are its only debt. b.Calculate the cost of retained earnings. c.Calculate the cost of new common stock. d.Calculate the weighted average cost of capital assuming Meacham's total capital budget is $30 million.

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

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

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 debt measures the cost of a bank loan,while the cost of preferred stock is used as a proxy for the cost of a new bond issue.

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 Parker's WACC?

Toto and Associates' preferred stock is selling for $27.50 a share.The firm nets $25.60 after issuance costs.The stock pays an annual dividend of $3.00 per share.What is the cost of existing,and new,preferred stock respectively?

The mixture of financing sources used by a firm will vary from year to year,so many firms use target capital structure proportions when calculating the firm's weighted average cost of capital.

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%.

Texas Transport has five possible investment projects for the coming year.Each project is indivisible.They are: The firm's weighted marginal cost of capital schedule is 12 percent for up to $6 million of investment; 16 percent for between $6 million and $18 million of investment; and above $18 million the weighted cost of capital is 18 percent.The optimal capital budget is

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.Crandal's flotation expense on the new bonds will be $50 per bond.Crandal's marginal tax rate is 35%.What is the pre-tax cost of debt for the newly-issued bonds?