QUESTION: 35 Topic 1: Part 2 Sec One (1 to 52)

The DCL Corporation is preparing to evaluate the capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods of analyses. the cost of capital for the firm must be estimated. The following information for DCL Corporation is provided.
· Market price of common stock is $50 per share. · The dividend next year is expected to be $2.50 per share. · Expected growth in dividends is a constant 10%. · New bonds can be issued at face value with a 13% coupon rate. · The current capital structure of 40% long-term debt and 60% equity is considered to be optimal
· Anticipated earnings to be retained in the coming year are $3 million.
· The firm has a 40% marginal tax rate.
If the firm must assume a 10% flotation cost on new stock issuances. what is the cost of new common stock?

1611%.
15.56%.
15.05%.
15.00%.

Answer(s): B

Explanation:

The formula to determine the cost of retained earnings, with the additional flotation cost entered into the calculation, is Cost of new common stock = {D, + [P x (1 -- Flotation cost)]} + G
Where: Di = next dividend
Po = current price
G = growth rate in dividends per share (but the model assumes that the dividend-payout ratio, retention rate, and therefore the EPS growth rate are constant). This yields a cost of new common stock of 15.56%. Cost of new common stock = {$2.50 ` [$50.00 x (1.0-- 0..1)] + 01
= ($2.50 + $45.00) + 01
= 0.0556 + 0.1
= 0.1556

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QUESTION: 36 Topic 1: Part 2 Sec One (1 to 52)

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When calculating a firm's cost of capital, all of the following are true except that

The cost of capital of a firm is the weighted average cost of its various financing components.
The calculation of the cost of capital should focus on the historical costs of alternative forms of financing rather than market or current costs.
All costs should be expressed as after-tax costs.
The time value of money should be incorporated into the calculations.

Answer(s): B

Explanation:

The cost of capital of a firm is the current, weighted average, after-tax cost of the firm's various financing components Historical costs are irrelevant.

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QUESTION: 37 Topic 1: Part 2 Sec One (1 to 52)

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Which of the following is true regarding the calculation of a firms cost of capital?

The cost of capital of a firm is the weighted-average cost of its various financing components
All costs should be expressed as pre-tax costs
The time value of money should be excluded from the calculations.
The cost of capital is the cost of equity.

Answer(s): A

Explanation:

The cost of capital of a firm is the current, weighted-average, after-tax cost of the firm's various financing components. Historical costs are irrelevant. Rogers. Inc. operates a chain of restaurants located in the Southeast. The company has steadily grown to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling of the restaurant, and the company is now considering two financing alternatives. The first alternative would consist of o Bonds that would have a 9% coupon rate and reissued at their base amount would net $19.2 million after a 4% flotation cost
o Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
o Common stock that would yield $24 million after a 5% flotation cost o The second alternative would consist of a public offering of bonds that would have an 11% market rate and would net $48 million alter flotation costs. Rogers' current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred stock, and 50% common stock. The current market value of the common stock is $30 per share, and the common stock dividend during the past 12 months was $3 per share. Investors are expecting the growth rate of dividends to equal the historical rate of 6%. Rogers is subject to an effective income tax rate of 40%

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QUESTION: 38 Topic 1: Part 2 Sec One (1 to 52)

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The after-tax cost of the common stock proposed in Rogers' first financing alternative would be

16.00%
16.53%
16.60%
17.16%

Answer(s): D

Explanation:

To determine the cost of new common stock, the dividend growth model is adjusted to include flotation cost as follows:

Rogers, Inc. operates a chain of restaurants located in the Southeast. The company has steadily grown to its present size of 48 restaurants. The board of directors recently approved a large-scale remodeling of the restaurant, and the company is now considering two financing alternatives.
o The first alternative would consist of
o Bonds that would have a 9% coupon rate and reissued at their base amount would net $19.2 million after 84% flotation cost

o Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
o Common stock that would yield $24 million after a 5% flotation cost o The second alternative would consist of a public offering of bonds that would have an 11% market rate and would net $48 million after flotation costs. Rogers' current capital structure, which is considered optimal, consists of 40% long-term debt, 10% preferred stock, and 50% common stock. The current market value of the common stock is $30 per share, and the common stock dividend during the past 12 months was $3 per share Investors are expecting the growth rate of dividends to equal the historical rate of 6%. Rogers is subject to an effective income tax rate of 40%.

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QUESTION: 35 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 36 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 37 Topic 1: Part 2 Sec One (1 to 52)

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QUESTION: 38 Topic 1: Part 2 Sec One (1 to 52)

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