1. A quick history: When I was taking finance classes in the early 1990s, My finance professor, an intimidating guy from Rochester, NY, impressed upon us all that we'd have to be fools not to be earning 10% in the market. This was largely due to the times. Everyone made money in the early 90s. The way you measure your gains against everyone else is by using CAPM. Your text mentions some shortfalls of CAPM that have popped up over the years.

If we assume the problems with CAPM were always there, how might the prevalent use of CAPM have led to irrational capital pricing decisions and how might that affect the value of a company?

2. Tip Top Hats is expected to grow at a 4 % rate for as long as it is in business. Currently the company's common stock is selling for $34 per share. The most recent dividend paid by Tip Top Hats was $4.25 per share. If new common stock is issued, Tip Top Hats will incur flotation costs equal to 8.5%

• What is the company's cost of retained earnings?
• What is its cost of new common equity?
• What are the advantages/disadvantages of financing an expansion with debt rather than equity?
• Does this change if you are financing a replacement project?