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Exam 13: Cost of Capital

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Question 71

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Why does a new issue of common stock have a higher cost of capital than retained earnings?

A) New common stock has floatation costs.
B) Existing common shareholders have seniority over new common shareholders.
C) New common stock must pay a higher dividend.
D) Retained earnings pertains to cash which has a zero cost of capital.

E) A) and B)
F) A) and C)

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Question 72

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Assume the following information about a firm's capital components: $\begin{array}{lll}\text { Debt } & \text { Capital Structure } & \text { Cost } \\\text { Preferred stock } & \$ 20,000 & 8 \% \\\text { Common stock } & \$ 20,000 & 11 \% \\& \$ 60,000 & 14 \%\end{array}$ The firm's WACC is:

A) 11.00%.
B) 11.90%.
C) 12.20%.
D) 12.05%.

E) A) and C)
F) A) and D)

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Question 73

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Which of the following is true of the book value of capital in calculating the WACC?

Which of the following is false?

The least precisely known capital component cost is:

Use the dividend growth or Gordon model to develop the cost of retained earnings if last year's dividend was $2.25, the anticipated constant growth rate is 5% the stock's selling price today is $36 per share, and flotation costs are estimated to be 11%?

Calculate the cost of preferred stock for Ohio Valley Power Company, which is planning to sell $100 million of $3.25 cumulative preferred stock to the public at a price of $25 per share. Flotation costs are $1.00 per share. Ohio Valley has a marginal income tax rate of 40%.

Witin Inc's stock price is $34.25 and its recent quarterly dividend is $0.25. Investors generally believe Witin will grow at 10% into the foreseeable future. Witin plans to sell one million shares of new stock to raise capital for an expansion project. What will be the cost of new equity if the if flotation costs are 8%?

A firm that's subject to a 40 percent tax rate has debt of $60M, equity of $140M, and no preferred stock. What is the firm's cost of capital (WACC) if its pretax cost of new debt is 12 percent, the pretax cost of its old debt is 8%, and its cost of equity is 14.5 percent?

The mix of capital components in use by a company at a point in time is known as its capital structure. This capital structure is generally described in terms of percentages referring to the relative sizes of the components.

The firm's cost of capital is the interest rate the firm should use to discount the cash flows of any proposed capital project.

Capital structures based on book and market values are generally different because:

Overland's preferred stock was issued 3 years ago to yield 10% of its par value of $30. The stock is selling in the market today for $50. Assuming that Overland pays 15% in flotation costs on new security issues, calculate the cost of preferred stock financing.

Capital refers to funds acquired for use over long periods of time for the purpose of:

Generally, the return on an equity investment is higher than the return on debt or preferred stock because:

Zylon Inc. plans net income of $10 million next year and typically pays 40% of its earnings in dividends. Its capital structure is one third equity and two thirds debt with no preferred stock. Zylon's MCC curve will break at:

Haverty Corp's bonds are selling to yield new investors a return of 9%, while its preferred stock is yielding 11%. Flotation costs are 10% of the proceeds of new issues sold to the public, and the firm's tax rate is 40%. The company just paid a dividend of $2.00 and is expected to grow at 6% indefinitely. Its stock is selling for $21.20. a. What is Haverty's cost of debt? b. What is Haverty's cost of preferred stock? c . What is Haverty's cost of retained earnings using the expected growth approach? d.What is Haverty's cost of new equity?

Learner Lanes, a producer of bowling balls, needs $2.5 million to expand operations. You look at the firm's balance sheet and find the following totals: $\begin{array}{ll}\text { Current liabilities: } & \$ 9,000 \\\text { Longsterm debt: } & \$ 25,000 \\\text { Preferred stock: } & \$ 10,000 \\\text { Common stock: } & \$ 56,000\end{array}$ Assuming that these ratios are consistent with the firm's target capital structure, cost of capital based calculations would assume that ____ is raised through the issuance of new common stock.

A firm has a previous debt issue on its balance sheet that pays coupons of 8% annually. Newer bonds with equivalent maturity would have 10% annual coupons in order to sell at par value. Based on this information, which statement is true?

If a firm issuing additional common equity can estimate the return investors require on its stock (k_e) at 12% and knows that flotation costs are about 18%, its component cost of equity capital for the new funds will be: