Exam 9: The Cost of Capital

Toombes,Inc.is issuing new common stock at a market price of $55.Dividends last year were $3.30 per share and are expected to grow at a rate of 6%.Flotation costs will be 5% of the market price.What is Toombes' cost of retained earnings,and new equity,respectively?

Clanton Company is financed 75 percent by equity and 25 percent by debt.If the firm expects to earn $30 million in net income next year and retain 40% of it,how large can the capital budget be before common stock must be sold?

Jones Company has a target capital structure of 30% debt,15% preferred stock,and 55% common equity.The company's after-tax cost of debt is 7%,its cost of preferred stock is 11%,its cost of retained earnings is 15%,and its cost of new common stock is 16%.The company stock has a beta of 1.5 and the company's marginal tax rate is 35%.What is the company's weighted average cost of capital if retained earnings are used to fund the common equity portion?

Once the weighted average cost of capital (WACC)is determined then all projects of average risk will be compared to the original WACC regardless of the size of the capital budget.

Joe's Discount Club currently has a weighted average cost of capital of 12%.Joe's has been growing rapidly over the past several years,selling common stock in each year to finance its growth.However,due to difficult economic times this year,Joe's decides to cut its dividend and increase its retained earnings so that the common equity portion of its capital structure will include only retained earnings and no new common stock will be sold.Joe's weighted average cost of capital this year should be

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 new common stock is

The capital asset pricing model uses three variables to evaluate required returns on common equity: the risk free rate,the beta coefficient,and the market risk premium.

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

Which of the following should NOT be considered when calculating a firm's WACC?

Higher flotation costs will result in all of the following except:

A company's capital structure mix is based on the proportion of fixed versus variable costs in its optimal production process.

The preferred stock of Wells Co.sells for $17 and pays a $1.75 dividend.The net price of the stock after issuance costs is $15.30.What is the cost of capital for new preferred stock?

A company has preferred stock that can be sold for $21 per share.The preferred stock pays an annual dividend of 3.5% based on a par value of $100.Flotation costs associated with the sale of preferred stock equal $1.25 per share.The company's marginal tax rate is 35%.Therefore,the cost of preferred stock is:

Which of the following statements is most correct?

Other things equal,management should retain profits only if the company's investments within the firm are at least as attractive as the stockholders' other investment opportunities.

Using the weighted cost of capital as a cutoff rate assumes that the riskiness of the project being evaluated is similar to the riskiness of the company's existing assets.

Jones Distributing Corp.can sell common stock for $27 per share and its investors require a 17% return.However,the administrative or flotation costs associated with selling the stock amount to $2.70 per share.What is the cost of capital for Jones Distributing if the corporation raises money by selling common stock?

Toto and Associates' preferred stock is selling for $27.50 a share.The firm nets $25.60 after issuance costs.The stock pays an annual dividend of $3.00 per share.What is the cost of existing,and new,preferred stock respectively?

If a firm's tax rate increases then its weighted average cost of capital increases also.

Durocorp has a target capital structure of 30% debt and 70% equity.Durocorp is planning to invest in a project that will necessitate raising new capital.New debt will be issued at a before-tax yield of 14%,with a coupon rate of 10%.The equity will be provided by internally generated funds so no new outside equity will be issued.If the required rate of return on the firm's stock is 22% and its marginal tax rate is 35%,compute the firm's cost of capital.