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Cost of Capital - Solutions9

# Cost of Capital - Solutions9 - C D E \$1,625,000 \$ 850,000...

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Old Exam Questions - Cost of Capital - Solutions Page 28 of 42 Pages * C. \$1,625,000 D. \$ 850,000 E. \$1,950,000 K D = (8.0%)(1-.4) = 4.8% K S = [\$2.45 / \$35.00] + 6.0% = 13.0% K e = [\$2.45 / (\$35.00)(1 - .125)] + 6.0% = 14.0% Firm will switch from K S to K e when the capital budget hits \$350,000 / .70 = \$500,000 Below \$500,000: WACC = (4.8%)(.30) + (13.0%)(.70) = 1.44% + 9.10% = 10.54% Above \$500,000: WACC = (4.8%)(.30) + (14.0%)(.70) = 1.44% + 9.80% = 11.24% Therefore, the firm should take on Projects A-D and the size of the optimal capital budget should be \$1,625,000. 38. An analyst has collected the following information regarding your company: The company’s capital structure is 75 percent equity, 25 percent debt. The before-tax yield to maturity on the company’s bonds is 8 percent and the bonds are selling at par value. The company’s dividend next year is forecasted to be \$1.25 a share. The company expects that its dividend will grow at a constant rate of 6 percent a year. The company’s stock price is \$20. The company’s tax rate is 40 percent. The company anticipates that it will need to raise new common stock this year. Its investment bankers anticipate that the total flotation cost will equal 12.5 percent of the amount issued -- you may assume that the company accounts for flotation costs by adjusting the component cost of capital. Given this information, determine what the company’s WACC will be when it is forced to issue new shares of common stock. A. 10.736% B. 9.914% C. 10.349% D. 9.627% * E. 11.055%

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