Cost of Capital - Homework

Questions

1. What does the cost of capital represents? What is should reflect?

2. How do taxes affect the cost of debt?

3. What are the retained earnings? Do they have any costs for the firm?

4. What is the major cost incurred in issuing new equity?

5. What does the WACC represents?

Problems

1-A Company's perpetual preferred stock sells for $102.50 per share, and it pays a $9.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock?

2- You have been provided with the following data: D1 = $1.30; P0 = $42.50; and g = 7.00% (constant). What is the cost of equity from retained earnings based on the DCF approach? If your company is going to issue new equity, it will incur an additional 6% flotation costs what is the cost of new equity?

3- You have been provided with the following data: RF = 5.00%; (RM - RF) = 5.00%; and b = 1.15. What is the cost of equity from retained earnings based on the CAPM approach?

4- Suppose your company's beta is 0.85, the risk free rate is 4.5% while the market return is 12%. What is the cost of equity from retained earnings based on the CAPM?

5- Several years ago your company sold a $1,000 par value, non-callable bonds that now has 12 years to maturity and a 8.00% annual coupon that is paid semiannually. The bond currently sells for $925, and the company's tax rate is 40%. What is the component cost of debt for use in the WACC calculation?

6- Your company's target capital structure is 35% debt, 15% preferred, and 50% common equity. The interest rate on new debt is 7.50%, the yield on the preferred is 7.00%, the cost of retained earnings is 12. 5%, and the tax rate is 40%. The firm will not be issuing any new stock. What is the WACC?

7- Suppose that your company just paid a dividend of $1.2; the dividends are expected to grow at a constant rate of 5% indefinitely. Today's market price/share is $45. Suppose also that your company has some bonds outstanding in the market selling for $1,035. The bonds have 8 years left to maturity, with 8% coupon rate that pay a semi-annually. If your company's capital structure is 35% debt and 65% equity, with the tax rate of 40% what is the WACC?

8-A company will issue preferred stock to finance a new project. The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised that flotation costs on the new preferred issue would be 5% of the selling price. The marginal tax rate is 30%. What is the relevant cost of new preferred stock?

9-A company will issue new common stock to finance an expansion. The existing common stock just paid a $1.50 dividend, and dividends are expected to grow at a constant rate 8% indefinitely. The stock sells for $45, and flotation expenses of 5% of the selling price will be incurred on new shares. What is the cost of new common stock?

10-A company has a capital structure that consists of $7 million of debt, $2 million of preferred stock, and $11 million of common equity, based upon current market values. The yield to maturity on its bonds is 7.4%, and investors require an 8% return on the company's preferred and a 14% return on the common stock. If the tax rate is 35%, what is the WACC?