Question
A firm 's targe t capital structure is 60 percent debt and 40 percent common equity. The firm's common stock has just paid a dividend
A firm
's targe
t capital structure is
60
percent debt and
40
percent common equity. The
firm's common stock has just paid a dividend of $2 per share. It is expected that the
dividends of this firm will grow at a rate of 10 percent per year in the future. The current
p
rice of the common shares is $3
0
. If new common shares are issued, it will be
necessary to
incur flotation costs of $5 per share
. The firm's bonds have a par value of
$1,000
;
a
coupon rate of
7
percent
paid annually
;
10 years to maturity
;
and currently s
ell
for $1,0
5
0 each. Flotation costs on
similar
new bonds would be
4
percent of the par
value on an after
-
tax basis. The firm is considering a project with an investment of $
10
million. The firm
doesn't have enough cash
for the investment
and will have
to issue
common shares to raise the $
10
million.
What is the required
rate of
return on this investment if the firm's tax rate is
40
percent
and the project has the same level of risk as the firm?
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