Old Exam Questions  Cost of Capital
Page 14 of 27 Pages
20.
Assume that a company just paid a $1.50 per share dividend on its common stock (D
0
=
$1.50), that the dividend is expected to grow at a constant rate of 8 percent per year,
and that investors require a 12 percent rate of return. Now assume that if the company
issues additional stock, it must pay its investment banker a flotation cost of $2.50 per
share. Given this information, determine the cost of new external equity, K
e
.
A.
12.15%
B.
12.59%
C.
12.37%
D.
12.48%
E.
12.26%
21.
Assume that a firm’s optimal capital structure consists of 30% debt at a beforetax cost
of debt (K
D
) of 6 percent, 10% preferred stock at a cost of preferred (K
P
) of 8 percent,
and 60% stock; that the firm’s tax rate is 40%; and that the firm’s weighted average
cost of capital is equal to 9.56 percent (assume retained earnings and ignore flotation
costs). Now assume that markets are in equilibrium (required rates are equal to
expected rates), that the current price (Year 0) of the firm’s “constant growth” stock is
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 Spring '08
 Staff
 Cost Of Capital, Dividend yield, ModiglianiMiller theorem

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