Exam 9: The Cost of Capital

Nico Trading Corporation is considering issuing preferred stock. The preferred stock would have a par value of $75 and a preferred dividend of 7.5 percent of par. In order to issue the stock, Nico trading would have to pay flotation costs of 6 percent of par value. Given this information, Nico Trading's cost of preferred stock would be 7.98 percent.

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

In comparing the constant growth model and the capital asset pricing model (CAPM) to calculate the cost of common stock equity,

Since preferred stock is a form of ownership, it has no maturity date.

The Gordon model is based on the premise that the value of a share of stock is equal to sum of all future dividends it is expected to provide over an infinite time horizon.

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.

The amount of preferred stock dividends that must be paid each year may be stated in dollars or as a percentage of the firm's earnings.

The constant growth model uses the market price as a reflection of the expected risk-return preference of investors in the marketplace.

The cost of retained earnings equity for Tangshan Mining would be 18.00 percent if the expected return on U.S. Treasury Bills is 5.00 percent, the market risk premium is 10.00 percent, and the firm's beta is 1.3.

A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost of issuing and selling the stock was $2 per share. The firm's marginal tax rate is 40 percent. The cost of the preferred stock is

Table 9.3 Balance Sheet General Talc Mines December 31, 2003 - Given this after-tax cost of each source of capital, the weighted average cost of capital using book weights for General Talc Mines is ________. (See Table 9.3)

The cost of common stock equity capital represents the return required by existing shareholders on their investment in order to leave the market price of the firm's outstanding share unchanged.

Firms underprice new issues of common stock for the following reason(s).

The four basic sources of long-term funds for the business firm are

Table 9.2 A firm has determined its optimal structure which is composed of the following sources and target market value proportions. Debt: The firm can sell a 15-year, $1,000 par value, 8 percent bond for $1,050. A flotation cost of 2 percent of the face value would be required in addition to the premium of $50. Common Stock: A firm's common stock is currently selling for $75 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.10. It is expected that to sell, a new common stock issue must be underpriced $2 per share and the firm must pay $1 per share in flotation costs. Additionally, the firm has a marginal tax rate of 40 percent. -The firm's cost of retained earnings is ________. (See Table 9.2)

A tax adjustment must be made in determining the cost of

In order to recognize the interrelationship between financing and investments, the firm should use ________ when evaluating an investment.

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

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 11.17 percent.

The constant growth valuation model the Gordon model is based on the premise that the value of a share of common stock is