Problem 21-06

The management of a conservative firm has adopted a policy of never letting debt exceed 40 percent of total financing. The firm will earn $20,000,000 but distribute 40 percent in dividends, so the firm will have $12,000,000 to add to retained earnings. Currently the price of the stock is $60; the company pays a $3 per share dividend, which is expected to grow annually at 10 percent. If the company sells new shares, the net to the company will be $57. Given this information, what is the

The rate of interest on the firms long-term debt is 8 percent and the firm is in the 32 percent income tax bracket. If the firm issues more than $2,300,000, the interest rate will rise to 9 percent. Given this information, what is the

The firm raises funds in increments of $4,000,000 consisting of $1,200,000 in debt and $2,800,000 in equity. This strategy maintains the capital structure of 30 percent debt and 70 percent equity. Develop the marginal cost of capital schedule through $11,000,000. Round your answers for the break-points to the nearest dollar and for the marginal costs to one decimal place.

The marginal cost of capital schedule:

$0 - $
	cost of debt: %
	cost of equity: %
	cost of capital: %

$ - $
	cost of debt: %
	cost of equity: %
	cost of capital: %

above $
	cost of debt: %
	cost of equity: %
	cost of capital: %

What impact would each of the following have on the marginal cost of capital schedule?

1. cost of retained earnings? Round your answer to one decimal place.

   %

2. cost of new common stock? Round your answer to one decimal place.

   %

3. cost of debt? Round your answer to one decimal place.

   %

4. cost of debt in excess of $2,300,000? Round your answer to one decimal place.

   %

5. the firms income tax rate increases

   If income tax rates were to rise, the effective cost of debt would -Select-declinerisenot changeItem 18 , and the marginal cost of capital would -Select-declinerisenot changeItem 19 at all levels.

6. the firm retains all of its earnings and the price of the stock is unaffected. Round your answers for the break-point to the nearest dollar and for the marginal costs to one decimal place.

   The marginal cost of capital schedule:

   $0 - $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %

   $ - $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %

   above $
   	cost of debt: %
   	cost of equity: %
   	cost of capital: %

7. $11,000,000 is insufficient to meet attractive investment opportunities

   If the firm needs more than $11,000,000 that fact -Select-increasesdecreasesdoes not alterItem 33 the marginal cost of capital schedule.