Exam 9: The Cost of Capital

The risk free rate of return is 2.5% and the market risk premium is 8%.Rogue Transport has a beta of 2.2 and a standard deviation of returns of 28%.Rogue Transport's marginal tax rate is 35%.Analysts expect Rogue Transport's dividends to grow by 6% per year for the foreseeable future.Using the capital asset pricing model,what is Rogue Transport's cost of retained earnings?

The after-tax cost of debt is equal to one minus the marginal tax rate times the yield to maturity on the firm's outstanding debt.

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

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?

If a firm were to earn exactly its cost of capital,we would expect the price of its common stock to remain unchanged.

Calculating the cost of capital for divisions within a company is not recommended because the data is too fragmented and all divisions are part of the same company in any case.

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

Two considerations that cause a corporation's cost of capital to be different than its investors' required returns are

Johnson Production Company paid a dividend yesterday of $3.50 per share.The dividend is expected to grow at a constant rate of 10% per year.The price of KayCee's common stock today is $40 per share.If KayCee decides to issue new common stock,flotation costs will equal $4.00 per share.KayCee's marginal tax rate is 35%.Based on the above information,the cost of retained earnings is

Dickerson Corporation's common stock is currently selling for $38.Last year's dividend was $4.00 per share.Investors expect dividends to grow at an annual rate of 7 percent indefinitely.Flotation costs of 4% will be incurred when new stock is sold. a.What is the cost of internal common equity? b.What is the cost of new common equity?

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.

Once the weighted average cost of capital (WACC)is determined then all projects of average risk will be compared to the original WACC regardless of the size of the capital budget.

The required return of a preferred stockholder,r_ps,is higher than the cost of preferred stock for the corporation because stockholder's must pay federal taxes on their dividend income.

The preferred stock of Wells Co.sells for $17 and pays a $1.75 dividend.The net price of the stock after issuance costs is $15.30.What is the cost of capital for new preferred stock?

All else equal,an increase in beta results in

Two factors that cause the investor's required rate of return to differ from the company's cost of capital are

Because investors like dividends,the higher the company's dividend growth rate,the lower the company's cost of common equity.

QRM,Inc.'s marginal tax rate is 35%.It can issue 10-year bonds with an annual coupon rate of 7% and a par value of $1,000.After $12 per bond flotation costs,new bonds will net the company $966 in proceeds.Determine the appropriate after-tax cost of new debt for the firm to use in a capital budgeting analysis.

A corporation's cost of common equity may be estimated using either a dividend valuation model or the capital asset pricing model.

Mountain Retreat and Resort 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.The firm's flotation expense on the new bonds will be $50 per bond.The firm's marginal tax rate is 35%.What is the relevant cost of the new bonds for capital budgeting purposes?