Exam 9: The Cost of Capital

Use of the capital asset pricing model (CAPM) in measuring the cost of common stock equity differs from the constant-growth valuation model in that it directly considers the firm's risk as reflected by beta.

What would be the cost of new common stock equity for Tangshan Mining if the firm just paid a dividend of $4.25, the stock price is $55.00, dividends are expected to grow at 8.5 percent indefinitely, and flotation costs are $6.25 per share?

In computing the weighted average cost of capital, the historical weights are either book value or market value weights based on actual capital structure proportions.

The marginal cost of capital is a relevant cost of capital for evaluating a firm's future investment opportunities.

The weighted average cost of capital (WACC) reflects the expected average future cost of capital over the long run.

A firm has determined it can issue preferred stock at $115 per share par value. The stock will pay a $12 annual dividend. The cost of issuing and selling the stock is $3 per share. The cost of the preferred stock is ________.

The cost of capital is a dynamic concept and it is affected by economic and firm-specific factors such as business risk and financial risk.

In computing the weighted average cost of capital, from a strictly theoretical point of view, the preferred weighing scheme is target market value proportions.

The cost of new common stock is normally greater than any other long-term financing cost.

Generally, the order of cost, from the least expensive to the most expensive, for long-term capital of a corporation is ________.

Table 9.1 A firm has determined its optimal capital structure which is composed of the following sources and target market value proportions. Debt: The firm can sell a 12-year, $1,000 par value, 7 percent bond for $960. A flotation cost of 2 percent of the face value would be required in addition to the discount of $40. Preferred Stock: The firm has determined it can issue preferred stock at $75 per share par value. The stock will pay a $10 annual dividend. The cost of issuing and selling the stock is $3 per share. Common Stock: A firm's common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. Its dividend payments have been growing at a constant rate for the last four years. Four years ago, the dividend was $1.50. It is expected that to sell, a new common stock issue must be underpriced $1 per share in floatation costs. Additionally, the firm's marginal tax rate is 40 percent. -The weighted average cost of capital up to the point when retained earnings are exhausted is ________. (See Table 9.1)

Nico Trading Corporation is considering issuing long-term debt. The debt would have a 30-year maturity and a 10 percent coupon rate. In order to sell the issue, the bonds must be underpriced at a discount of 5 percent of face value. In addition, the firm would have to pay flotation costs of 5 percent of face value. The firm's tax rate is 35 percent. Given this information, the after-tax cost of debt for Nico Trading would be ________.

One major expense associated with issuing new shares of common stock is ________.

Weights that use accounting values to measure the proportion of each type of capital in a firm's financial structure are called book value weights.

A tax adjustment must be made in determining the cost of ________.

Table 9.3 Balance Sheet General Talc Mines December 31, 2014 -General Talc Mines has compiled the following data regarding the market value and cost of the specific sources of capital. Market price per share of common stock $50 Market value of long-term debt $980 per bond The weighted average cost of capital using market value weights is ________. (See Table 9.3)

The ________ is a weighted average of the cost of funds which reflects the interrelationship of financing decisions.

The cost of common stock equity capital represents the return required by existing shareholders on their investment.

The weights used in weighted average cost of capital must be ________.

The cost of capital is the rate of return a firm must earn on investments in order to increase the firm's value.