Exam 9: The Cost of Capital

Mars Car Company 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 Mars Co.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?

In general,the least expensive source of capital is

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.

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

Royal Mediterranean Cruise Line's 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 Royal's retained earnings?

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

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

A security with a reasonably stable price will have a lower required rate of return than a security with an unstable price.

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.

DEF Company's preferred stock is currently selling for $28.00,and pays a perpetual annual dividend of $2.00 per share.Underwriters of a new issue of preferred stock would charge $3 per share in flotation costs.The firm's tax rate is 40%.Compute the cost of new preferred stock for DEF.

Asian Trading Company 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 Asian Trading Company's stock today is $29 per share.If Asian Trading Company decides to issue new common stock,flotation costs will equal $2.50 per share.Asian Trading Company's marginal tax rate is 35%.Based on the above information,the cost of retained earnings is

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

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

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

SkyHigh Airlines has five possible investment projects for the coming year.Each project is indivisible.They are: SkyHigh'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:

Cost of capital is

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

In order to create value a corporation must earn a rate of return on its invested capital that is higher than the market's required rate of return on that invested capital.

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

A short-term T-bill's rate of return should be used in the CAPM formula to determine the cost of equity capital regardless of the length of the project under consideration.