Investors require a return of 13.7% on the money they invest. However, the firm will receive less than investors invest due to flotation costs, so it must earn more than 13.7% to provide that return to investors. It turns out that if the firm can earn 14.3% on the funds it receives, it can provide the 13.7% to investors.Alternatively, flotation costs could have been expressed as a dollar amount. In that scenario, we would have been told that the issuance of new common stock carried a flotation cost of $2.31 per share of stock. On that basis we could have calculated the cost of new common stock by adjusting the price in the following manner, P0 − $F.re from new stock =Either manner of flotation cost adjustment is acceptable, it just depends upon the type of information you are given.Firms should utilize retained earnings to the greatest extent possible. However, if a firm has more good investment opportunities than can be financed with retained earnings, it may need to issue new common stock. The total amount of capital that can be raised before new stock must be issued is defined as the retained earnings breakpoint.If Allied's addition to retained earnings in 2009 is expecteed to be $66 milion; and its target capital structure consists of 45% debt, 2% preferred, and 53% equity. What is its retained earnings breakpoint?wdwpwsThis calculation indicates that at a capital budget of $124.5 million Allied would not have to raise new equity. At any capital budget larger than this amount, Allied would exhaust its retained earnings and would have to issue new common stock.WEIGHTED AVERAGE COST OF CAPITAL (Section 10-7)The weighted average cost of capital (WACC) is calculated using the firm's target capital structure together with its after-tax cost of debt, cost of preferred stock, and cost of common equity. A firm's target capital structure consists of 45% debt, 2% preferred stock, and 53% common equity. Using the relevant costs calculated previously, and assuming that all equity will come from retained earnings, what is the firm's WACC? (For the cost of equity, use the CAPM approach.) 0.00.51.01.52.00%2%4%6%8%10%12%14%Effect of Beta on Cost of EquityBetaCo st o f Equity A B C D E F G 1 2 3 4 5 6 7 8 9 10 11 12
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