Unformatted text preview: Note, though, that the after-tax yield to a corporate investor, and the after-tax cost to the issuer, are higher on preferred stock than on debt. d. 1. What are the two primary ways companies raise common equity? Answer: A firm can raise common equity in two ways: (1) by retaining earnings and (2) by issuing new common stock. d. 2. Why is there a cost associated with reinvested earnings? Answer: Management may either pay out earnings in the form of dividends or else retain earnings for reinvestment in the business. If part of the earnings is retained, an opportunity cost is incurred: stockholders could have received those earnings as dividends and then invested that money in stocks, bonds, real estate, and so on. d. 3. Harry Davis doesn’t plan to issue new shares of common stock. Using the CAPM approach, what is Harry Davis’ estimated cost of equity? Answer: r s = 0.07 + (0.06)1.2 = 14.2%. Mini Case: 10 - 15...
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- Spring '08