Exam 8: Cost of Capital

Why is external common equity capital more expensive then internal common equity capital?

If a project is to be 100% financed with debt, then the cost of debt-not the weighted average cost of capital-should be used to evaluate the project.

What is meant by measuring the weighted average cost of capital on a marginal basis?

The cost of capital raised by the issuance of bonds is typically lower than the cost of capital raised from the issuance of preferred stock or common stock.

Spencers Magic Shows Incorporated is financed 100% with equity and intends to remain this way. Spencers' common stock beta is 0.85, the expected market return average market return)is 14%, and the risk-free rate is 6%. If all of Spencers' equity is internal, what are the cost of equity and the weighted average cost of capital for Spencers?

Tokyo Food Supplies Corporation sold an issue of 12-year bonds. The bonds sold at $980 each. After issuance costs, Tokyo Food Supplies received $975 each. The maturity value is $1,000 each and the coupon rate is 9% and paid annually. What is the after-tax cost of debt for these bonds if Tokyo Food Supplies' marginal tax rate is 40%?

Which of the following is typically not treated as one of the components of capital in cost of capital schedule calculations?

Which model is typically used to estimate the cost of using external equity capital?

Marion's Miraculous Resorts has a current capital structure that is 50% equity, 40% debt, and 10% preferred stock. This is considered optimal. Marion is considering a $40 million capital budgeting project. Marion has estimated the following: After-tax cost of debt: 8.5% Cost of preferred stock: 9.5% Cost of internal equity: 14.0% If all equity comes from internal sources, what should Marion's cost of capital be for this project?

Shamas Famous Restaurants expects to pay a common stock dividend of $1.50 per share next year d₁). Dividends are expected to grow at a 4% rate for the foreseeable future. Shamas' common stock is selling for $18.50 per share and issuance costs are $3.50 per share. What is Shamas cost of internal equity?

Jose's Cantinas Incorporated plans to issue preferred stock at a price of $48 per share. The annual dividend will be $5.10 per share and issuance costs are expected to be $3.00 per share. What is the cost of raising funds with preferred stock for Jose's?

__________ represents the long-term or permanent sources of the firm's financing.

Alishas Travel Tours expects to sell a new bond issue at its par value. The coupon rate is 10 7/8%. Because issuance costs are so small, Alishas plans to ignore the impact of issuance costs on the after-tax cost. What is the after-tax cost of these bonds if Alishas' marginal tax rate is 40%?

A firm's weighted average cost of capital is the average cost of the various short-term sources of financing employed by the firm.

Issuance or flotation costs are the costs investors pay to brokers when they purchase common stock.

Shamas Famous Restaurants expects to pay a common stock dividend of $1.50 per share next year d₁). Dividends are expected to grow at a 4% rate for the foreseeable future. Shamas' common stock is selling for $18.50 per share and issuance costs are $3.50 per share. What is Shamas cost of external equity?

The cost of a firm's internal common equity is generally higher than the costs of a firm's external common equity due to issuance costs.

Taxes are a relevant cost that should be accounted for in the firm's weighted average cost of capital.

Preferred stock has higher seniority than bonds and common stock.

Penny's Budget Gourmet Restaurants has a current capital structure that is 70% equity, 20% debt, and 10% preferred stock. This is considered optimal. Penny is considering a $100 million capital budgeting project. Penny has estimated the following: After-tax cost of debt: 7.0% Cost of preferred stock: 8.0% Cost of internal equity: 13.0% Cost of external equity: 15.0% Penny expects to have $40 million of new retained earnings available to finance this project. What is Marion's cost of capital for this project?