Cost of Capital Paper 4

1

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%.
Assume that the after-tax cost of debt is 7% and the cost of equity is 12%. Determine the weighted-average cost of capital to DQZ.






2

The common stock of the Nicolas Corporation is currently selling at $80 per share. The leadership of the company intends to pay a $4 per share dividend next year. With the expectation that the dividend will grow at 5% perpetually, what will the market’s required return on investment be for Nicolas common stock?






3

Enert, Inc.’s current capital structure is shown below. This structure is optimal, and the company wishes to maintain it.
Debt 25%
Preferred equity 5
Common equity 70
Enert’s management is planning to build a $75 million facility that will be financed according to this desired capital structure. Currently, $15 million of cash is available for capital expansion. The percentage of the $75 million that will come from a new issue of common stock is






4

Which one of a firm’s sources of new capital usually has the lowest after-tax cost?






5

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?






6

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 restaurants, and the company is now considering two financing alternatives.
? The first alternative would consist of
? Bonds that would have a 9% coupon rate and reissued at their base amount would net $19.2 million after a 4% flotation cost
? Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
? Common stock that would yield $24 million after a 5% flotation cost
? The second alternative would consist of a public offering of bonds that would have a 9% coupon rate and an 11% market rate and would net $48 million after a 4% flotation cost.
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%. The after-tax cost of the common stock proposed in Rogers’ first financing alternative would be






7

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 restaurants, and the company is now considering two financing alternatives.
? The first alternative would consist of
? Bonds that would have a 9% coupon rate and reissued at their base amount would net $19.2 million after a 4% flotation cost
? Preferred stock with a stated rate of 6% that would yield $4.8 million after a 4% flotation cost
? Common stock that would yield $24 million after a 5% flotation cost
? The second alternative would consist of a public offering of bonds that would have a 9% coupon rate and an 11% market rate and would net $48 million after a 4% flotation cost.
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%.
The after-tax weighted marginal cost of capital for Rogers’ second financing alternative consisting solely of bonds would be






8

Maylar Corporation has sold $50 million of $1,000 par value, 12% coupon bonds. The bonds were sold at a discount and the corporation received $985 per bond. If the corporate tax rate is 40%, the after-tax cost of these bonds for the first year (rounded to the nearest hundredth percent) is






9

Acme Corporation is selling $25 million of cumulative, non-participating preferred stock. The issue will have a par value of $65 per share with a dividend rate of 6%. The issue will be sold to investors for $68 per share, and issuance costs will be $4 per share. The cost of preferred stock to Acme is






10

By using the dividend growth model, estimate the cost of equity capital for a firm with a stock price of $30.00, an estimated dividend at the end of the first year of $3.00 per share, and an expected growth rate of 10%.






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