Only Answer the Questions (Q)

a. What would be the after-tax cost of debt for a company with the following yields to maturity for its new bonds, if the applicable tax rate were 40 percent? (i) YTM = 7% (ii) YTM = 11% (iii) YTM = 13% b. How would the cost of debt change if the applicable tax rate were 34 percent?

(Q) Why is the cost of debt less after taxes than before taxes?

Frank Underwood, the treasurer of a manufacturing company, thinks that debt (YTM = 11%, tax rate = 40%) will be a cheaper option for acquiring funds compared to issuing new preferred stock. The company can sell preferred stock at $61 per share and pay a yearly preferred dividend of $8 per share. The cost of issuing preferred stock is $1 per share. Is Frank correct?

(Q) Is Frank correct in his cost analysis? What variable(s) would need to increase/decrease (and by how much) in order for the Cost of Preferred Stock to be equal to the Cost of Debt?

Twister Corporation is expected to pay a dividend of $7 per share one year from now on its common stock, which has a current market price of $143. Twisters dividends are expected to grow at 13 percent. a. Calculate the cost of the companys retained earnings. b. If the otation cost per share of new common stock is $4, calculate the cost of issuing new common stock.

(Q)Why is the Cost of Common Stock Equity the same as the Cost of Retained Earnings?

(Q) If the cost of new common equity is higher than the cost of internal equity, why would a firm choose to issue new common stock?

Amy Jolly is the treasurer of her company. She expects the company will grow at 4 percent in the future, and debt securities (YTM = 14%, tax rate = 30%) will always be a cheaper option to nance the growth. The current market price per share of its common stock is $39, and the expected dividend in one year is $1.50 per share. Calculate the cost of the companys retained earnings and check if Amys assumption is correct.

(Q)Is Amy correct in her cost analysis? What variable(s) would need to increase/decrease (and by how much) in order for the Cost of Equity to be equal to the Cost of Debt?

Margo Channing, the nancial analyst for Eves Broadway Production Company, has been asked by management to estimate a cost of equity for use in the analysis of a project under consideration. In the past, dividends declared and paid have been very sporadic. Because of this, Ms. Channing elects to use the CAPM approach to estimate the cost of equity. The rate on the short-term U.S. Treasury bills is 3 percent, and the expected rate of return on the overall stock market is 11 percent. Eves Broadway Production Company has a beta of 1.6. What will Ms. Channing report as the cost of equity?

(Q) Why is the CAPM Formula used instead of, or in addition to, the Dividend Growth Model?

Puppet Masters is considering a new capital investment project. The company has an optimal capital structure and plans to maintain it. The yield to maturity on Puppet Masters debt is 10 percent, and its tax rate is 35 percent. The market price of the new issue of preferred stock is $25 per share, with an expected per-share dividend of $2 at the end of this year. Flotation costs are set at $1 per share. The new issue of common stock has a current market price of $140 per share, with an expected dividend in one year of $5. Flotation costs for issuing new common stock are $4 per share. Puppet Masters dividends are growing at 10 percent per year, and this growth is expected to continue for the foreseeable future. Selected gures from last years balance sheet follow: Total Assets $1,000,000Long-Term Debt 300,000Preferred Stock 100,000Common Stock 600,000 Calculate the minimum expected return from the new capital investment project needed to satisfy the suppliers of the capital.

(Q)What does the weight refer to in the weighted average cost of capital? How would you calculate the weight of debt?

Fans By Fay Company has a capital structure of 60 percent debt and 40 percent common equity. The company expects to realize $200,000 in net income this year and will pay no dividends. The effective annual interest rate on its new borrowings increases by 3 percent for amounts over $500,000. a. At what capital budget size will Fans By Fays cost of equity increase? In other words, what is its equity break point? b. At what capital budget size will its cost of debt increase (debt break point)?

(Q) What would the Fans by Fay need to do if they wanted to raise Total Capital up to their Debt Break Point - $833,333? What would the dollar amount of their net income need to be? Would this cause their Marginal Cost of Capital (MCC) to increase or decrease?