Cost of Capital Paper 3

1

A preferred stock is sold for $101 per share, has a face value of $100 per share, underwriting fees of $5 per share, and annual dividends of $10 per share. If the tax rate is 40%, the cost of funds (capital) for the preferred stock is






2

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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.
The after-tax cost to FLF Corporation of the new bond issue is






3

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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 FLF Corporation must assume a 20% flotation cost on new stock issuances, what is the cost of new common stock?






4

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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.
The cost of using FLF Corporation retained earnings for financing is






5

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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.
The maximum capital expansion that FLF Corporation can support in the coming year without resorting to external equity financing is






6

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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.
Without prejudice to your answers from any other questions, assume that the after-tax cost of debt financing is 10%, the cost of retained earnings is 14%, and the cost of new common stock is 16%. If capital expansion needs to be $7 million for the coming year, what is the after-tax weighted-average cost of capital to FLF Corporation?






7

The FLF Corporation is preparing to evaluate capital expenditure proposals for the coming year. Because the firm employs discounted cash flow methods, the cost of capital for the firm must be estimated. The following information for FLF Corporation is provided:
? The market price of common stock is $60 per share.
? The dividend next year is expected to be $3 per share.
? Expected growth in dividends is a constant 10%.
? New bonds can be issued at face value with a 10% 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.
Without prejudice to your answers from any other questions, assume that the after-tax cost of debt financing is 10%, the cost of retained earnings is 14%, and the cost of new common stock is 16%. What is the marginal cost of capital to FLF Corporation for any projected capital expansion in excess of $7 million?






8

Williams, Inc., is interested in measuring its overall cost of capital and has gathered the following data. Under the terms described as follows, the company can sell unlimited amounts of all instruments.
? Williams can raise cash by selling $1,000, 8%, 20-year bonds with annual interest payments. In selling the issue, an average premium of $30 per bond would be received, and the firm must pay flotation costs of $30 per bond. The after-tax cost of funds is estimated to be 4.8%.
? Williams can sell $8 preferred stock at par value, $105 per share. The cost of issuing and selling the preferred stock is expected to be $5 per share.
? Williams’ common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7 per share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by $3 per share, and flotation costs are expected to amount to $5 per share.
? Williams expects to have available 100,000 of retained earnings in the coming year; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
? Williams’ preferred capital structure is
Long-term debt 30%
Preferred stock 20%
Common stock 50%
The cost of funds from the sale of common stock for Williams, Inc., is






9

Williams, Inc., is interested in measuring its overall cost of capital and has gathered the following data. Under the terms described as follows, the company can sell unlimited amounts of all instruments.
? Williams can raise cash by selling $1,000, 8%, 20-year bonds with annual interest payments. In selling the issue, an average premium of $30 per bond would be received, and the firm must pay flotation costs of $30 per bond. The after-tax cost of funds is estimated to be 4.8%.
? Williams can sell $8 preferred stock at par value, $105 per share. The cost of issuing and selling the preferred stock is expected to be $5 per share.
? Williams’ common stock is currently selling for $100 per share. The firm expects to pay cash dividends of $7 per share next year, and the dividends are expected to remain constant. The stock will have to be underpriced by $3 per share, and flotation costs are expected to amount to $5 per share.
? Williams expects to have available 100,000 of retained earnings in the coming year; once these retained earnings are exhausted, the firm will use new common stock as the form of common stock equity financing.
? Williams’ preferred capital structure is
Long-term debt 30%
Preferred stock 20%
Common stock 50%
If Williams, Inc., needs a total of 200,000, the firm’s weighted-average cost of capital would be






10

DQZ Telecom is considering a project for the coming year that will cost $50 million. DQZ plans to use the following combination of debt and equity to finance the investment.
? Issue $15 million of 20-year bonds at a price of $101, with a coupon rate of 8%, and flotation costs of 2% of par.
? Use $35 million of funds generated from earnings.
? The equity market is expected to earn 12%. U.S. Treasury bonds are currently yielding 5%. The beta coefficient for DQZ is estimated to be .60. DQZ is subject to an effective corporate income tax rate of 40%.
The before-tax cost of DQZ’s planned debt financing, net of flotation costs, in the first year is






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