Exam 14: The Cost of Capital

The expected dividend is $2.50 for a share of stock priced at $25. What is the cost of common equity if the long-term growth in dividends is projected to be 4%?

DIY Building Supplies has the following record of paying dividends What are the arithmetic and geometric average growth rates of DIY's dividend payments?

An increase in ________ will increase the cost of common equity.

Walker & Son is issuing a 10-year, $1,000 par value bond that pays 9% interest annually. The bond is expected to sell for $885. What is Walker & Son's after-tax cost of debt if the firm is in the 34% tax bracket?

Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. What is the after-tax cost of debt if the firm is in the 34% tax bracket?

The firm's weighted average cost of capital includes the cost of common stock, preferred stock and retained earnings, but not debt.

A strong stock market and reasonably good earnings have caused the price of the firm's common stock to increase by 25%.

When Starbuck's decided to acquire Seattle's Best Coffee Company, it presumably concluded that the

The weighted cost of capital assumes that the company maintains a constant debt to equity ratio.

Why is it important to use market-based weights rather than balance sheet weights when estimating a company's weighted average cost of capital?

Based on current market values, Shawhan Supply 's capital structure is 30% debt, 20% preferred stock, and 50% common stock. When using book values, capital structure is 25% debt, 10% preferred stock, and 65% common stock. The required return on each component is: debt,10% before tax; preferred stock, 11%; and common stock,18%. The marginal tax rate is 35%. What rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged?

Flotation costs are usually ignored when computing the NPV of projects financed with newly issued securities.

Problems with using the same company-wide cost of capital for all projects potentially include

The George Company, Inc., has two issues of debt. Issue A has a maturity value of 8 million dollars, a coupon rate of 8%, paid annually, and is selling at par. Issue B was issued as a 15 year bond 5 years ago. Its coupon rate is 9%, paid annually. Investors demand a pre-tax return of 9.3% on this bond. The maturity value of Issue B is 6 million dollars. The George company has a marginal tax rate of 35%. What is the company's after tax cost of debt?

The current total value of the firm is

Sutter Corporation's common stock is selling for $16.80 a share. Last year, Sutter paid a dividend of $.80. Investors are expecting Sutter's dividends to grow at a rate of 5% per year. What is the cost of common equity?

Because issuing common equity entails less risk to the firm, it is always less expensive than borrowing.

When investors increase their required rate of return, the cost of capital increases simultaneously.

Alpha has an outstanding bond issue that has a 7.75% semiannual coupon, a current maturity of 20 years, and sells for $967.97. The firm's income tax rate is 40%. What should Alpha use as an after-tax cost of debt for cost of capital purposes?

Reliable Metals plans to issue bonds that will mature in 20 years, will have a semi-annual coupon rate of 7%., and a Moody's rating of Aa2. Bonds of other metals companies with similar maturities and ratings currently yield an average of 6.3%.