Exam 9: The Cost of Capital

The cost of a particular source of capital (debt,preferred stock,common stock)is equal to the investor's required rate of return after adjusting for the effects of both flotation costs and corporate taxes.

Which of the following causes a firm's cost of capital (WACC)to differ from an investor's required rate of return on the company's common stock?

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 new common stock is

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.

CrochetCo is considering an investment in a project which would require an initial outlay of $350,000 and produce expected cash flows in years 1-5 of $95,450 per year.You have determined that the current after-tax cost of the firm's capital (required rate of return)for each source of financing is as follows: long-term debt currently makes up 25% of the capital structure,preferred stock 15%,and common stock 60%.What is the net present value of this project?

Financing with new common stock is generally more costly than financing with retained earnings due to increasing tax rates.

Keystone Corporation 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 new common stock be for Keystone Corp.?

If preferred stock pays a $5 annual dividend and sells for $50 the cost of preferred stock financing is 10% since dividends are not tax deductible and preferred stock is sold without flotation costs.

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?

Higher flotation costs will result in all of the following EXCEPT