Cost of Capital - Solutions6

# Cost of Capital- - P0 =(\$1 00(1.15.20.15 = \$23.00 Ke =(\$1 00(1.15(\$23 00(1.15 0 15 =[\$1.15 \$19.55 0.15 = 20 88 18 A firm has a mark et-value

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Old Exam Questions - Cost of Capital - Solutions Page 17 of 42 Pages P 0 = [(\$1.00)(1.15)] / [.20 - .15] = \$23.00 K e = [(\$1.00)(1.15)] / [(\$23.00)(1 - .15)] + 0.15 = [\$1.15 / \$19.55] + 0.15 = 20.88% 18. A firm has a market-value balance sheet as indicated below. The firm assumes that it can issue debt at a before-tax cost of 10 percent and has a marginal tax rate of 40 percent. The firm can meet their equity needs through additions to retained earnings and investors currently require a 16 percent rate of return on stock. If the firm issue preferred stock, it will pay a dividend of \$15 per year, and although investors will be willing to pay \$165 for each share of preferred, the firm will only net \$150 per share after accounting for related flotation expenses. Given this data, what is the firm’s weighted average cost of capital (or the marginal costs of capital for the first dollar to be raised)? Balance Sheet at Market Value (In Millions) Current Assets \$100.00 Long-term Debt \$75.00 Other Assets \$50.00 Preferred Stock \$15.00 Fixed Assets \$150.00 Equity \$210.00 Total Assets \$300.00 Total Liabilities and Equity \$300.00 A. 12.60% B. 12.80% C. 13.00% * D. 13.20% E. 13.40% Answer: D 13.20% W D = \$ 75/\$300 = .25 W P = \$ 15/\$300 = .05 W E = \$210/\$300 = .70 K D = .10 K P = \$15/\$150 = .10 K E = .16 WACC = (.25)(.10)(1-.40) + (.05)(.10) + (.70)(.16) = .015 + .005 + .112 = 13.20%

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## This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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Cost of Capital- - P0 =(\$1 00(1.15.20.15 = \$23.00 Ke =(\$1 00(1.15(\$23 00(1.15 0 15 =[\$1.15 \$19.55 0.15 = 20 88 18 A firm has a mark et-value

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