INTEGRATED CASE COLEMAN TECH

INTEGRATED CASE COLEMAN TECH - F WHAT IS THE...

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F. WHAT IS THE BOND-YIELD-PLUS-RISK-PREMIUM ESTIMATE FOR COLEMAN’S COST OF COMMON EQUITY? ANSWER: THE BOND-YIELD-PLUS-RISK-PREMIUM ESTIMATE IS 14 PERCENT: k s = BOND YIELD + RISK PREMIUM = 10.0% + 4.0% = 14.0%. G. WHAT IS YOUR FINAL ESTIMATE FOR k s ? ANSWER: k s ESTIMATES: METHOD ESTIMATE CAPM 14.2% DCF 13.8 k d + RP 14.0 AVERAGE 14.0 % H. EXPLAIN IN WORDS WHY NEW COMMON STOCK HAS A HIGHER PERCENTAGE COST THAN RETAINED EARNINGS. ANSWER: THE NEW INVESTMENT MUST PROVIDE A RETURN AT LEAST EQUAL TO THE INVESTORS’ OPPORTUNITY COST. IF THE COMPANY RAISES CAPITAL BY SELLING STOCK, THE COMPANY DOESN’T GET ALL OF THE MONEY THAT INVESTORS PUT UP. FOR EXAMPLE, IF INVESTORS PUT UP \$1000,000, AND IF THEY EXPECT A 17 PERCENT RETURN ON THAT \$100,000, THEN \$170,000 OF PROFITS MUST BE GENERATED. BUT IF FLOTATION COSTS ARE 25 PERCENT (\$250,000), THEN THE COMPANY WILL RECEIVE ONLY \$750,000 OF THE \$100,000 INVESTORS PUT UP. THAT \$80,000 MUST THEN PRODUCE A \$15,000 PROFIT, OR A 17/75 = 22.66% RATE OF RETURN VERSUS A 17 PERCENT RETURN ON EQUITY RAISED AS RETAINED EARNINGS.

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