The Cost of Capital

12) Define Cost of Capital

13) Why do firms calculate their weighted average cost of capital?

14) How does a firm's tax rate affect its cost of capital?

15) What is the effect of the flotation costs associated with a new security issue on a firm's weighted average cost of capital?

16) Please use your textbook to compute the following.

A) You Corp issued new stock at a market price of $35. The company paid $1.50 in dividends last year which is expected to grow at an annual rate of 5 percent forever. Flotation costs will consist of 6 percent of the market price. What will You Corp.'s cost of equity be for the new issue? (Look at the Cost of Equity section for guidance particularly in the dividend growth model )

B) Glendale Farms Co, is issuing a $1,000 par value bond which pays 7 percent annual interest and matures in 15 years. As an investor to the company, you are willing to pay $850 for the bond. Flotation costs will be 3 percent of market value. The company is at a 30 percent marginal tax bracket. What will be the firm's after-tax cost of debt on the bond. (Look at the Cost of Debt section for guidance = Similar to ex 9.1) )

17) Look at the information below. This table refers to Candy Enterprises. Currently common stock is being sold at for a price equal to its book value and the firm's bonds are selling at par. Crawford managers estimate that the market requires a 15 percent return on its common stock, the firm's command a yield to maturity of 8 percent, and the firm faces a tax rate at 34 percent.

Cash	$54,000
Accounts Receivable	458,000
Inventories	740,000	Long-term Debt	$1,259,000
Net Property, Plant & Equipment	1,895,500	Common Equity	1,888,500
Total Assets	$3,147,500		$3,147,500

Cost of debt financing	8%
Cost of equity	15%
Tax rate	34%
Market to book ratio	1

Based on the information above.

A) What is Candy Enterprises' weighted average cost of capital?

Component	Proportion	After-tax Cost	Product	Market Value/ Balance Sheet
Long-term Debt
Common Equity