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Cost of new common stock

1. If a firm needs additional capital from equity sources once the retained earnings breakpoint is reached, it will have to raise the capital by issuing new common stock.

a. True: Firms will raise all the equity they can from retained earnings before issuing new common stock, because capital from retained earnings is cheaper than capital raised from issuing new common stock.
b. False: Firms raise capital from retained earnings only when they cannot issue new common stock due to market conditions outside of their control

2. Wooten Co. is considering a one-year project that requires an inital investment of $475,000; however, in raising capital, Wooten will incur an additional flotation cost of 2.0%. At the end of the year, the project is expected to produce a cash inflow of $595,000. Determine the rate of return that Wooten expects to earn on the project after flotation costs are taken into account.

a. 18.2%
b. 22.8%
c. 17.1%
d. 19.4%

3. Wooten Co. has a current stock price of $22.35 and is expected to pay a dividend of $2.45 at the end of next year. The company's growth rate is expected to remain constant at 5.2%. If flotation costs represent 5.0% of funds raised what is the flotation-adjusted cost of new common stock?

a. 16.2%
b. 13.4%
c. 16.7%
d. 14.2%

4. Wooten Co.'s addition to earnings for this year is expected to be $420,000. Its target capital structure consists of 50% debt, 5% preferred, and 45% equity. Determine Wooten's retained earnings breakpoint:

a. $886,666
b. $933,333
c. $1,166,666
d. $1,026,666

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Hubert Koch
Hubert KochLv2
29 Sep 2019

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1. NCC Corporation is considering building a new facility in Texas. To raise money for the capital projects, the corporation plans the following capital structure: 30% of money will come from issuing bonds, and 70% will come from Retained Earnings or new common stock. The corporation does not currently have preferred stock. NCC Corporation will issue bonds with an interest rate of 8% up to $30 million dollars in bonds. After issuing $30 million in bonds, the interest cost will rise to 12.5%. The next dividend on common stock is expected to be $2.00 per share. The stock price is $25.00 per share, and is expected to grow at 3% per year. The flotation cost for issuing new common stock is estimated at 10%. NCC Corporation has $66 million in retained earnings that can be used. The tax rate for NCC Corporation is 35%.

A. What is the initial Weighed Average Cost of Capital (WACC) for NCC Corporation?

B. There are two breakpoints in NCC's capital structure. At what point does the first breakpoint occur?

C. At what point does the second breakpoint occur?

D. What is the Weighted Average Cost of Capital (WACC) after the first breakpoint?

E. What is the WACC after the second breakpoint?

F. The following projects are available for NCC Corporation to consider choosing.

Cost Cash Flow Each Year IRR
Project A $25 Million $7 Millions for 5 Years 12.38%
Project B $50 Million $15 Millions for 5 Years 15.24%
Project C $30 Million $7.5 Million for 6 years 13%
Project D $30 Million $8.8 Million for 5 Years 14.29%
Project E $40 Million $11 Million for 5 years 11.65%

Which projects should NCC accept, if any, and in which order should they be chosen?

Weighted Average Cost of Capital

A firm has determined its optimal capital structure, which is illustrated by the information below.

Source of Capital (Target Market Proportions)

Long term debt (20%)

Preferred Stock (10)

Common Stock Equity (70)

To expand operations, the firm is considering the following sources of financing its capital expenses:

Debt -The firm can sell 12-year, 1,000 par value bond paying a 7% annual coupon for $960. To issue the bond the firm will have to pay bond issuance or flotation cost of 2 percent of the face value of the bond.

Preferred Stock- the firm has determined that it can issue preffered stock at a par value price of $75 per share. The stock will pay $10 annual dividend. The cost of issuing and selling the stock is $3 per share.

Common Stock: A firms common stock is currently selling for $18 per share. The dividend expected to be paid at the end of the coming year is $1.74. The firms dividends have been growing at a constant rate of 4% per year for the last four years and are expected to sustain that growth rate thereafter.

New common stock issue- if the firm decides to issue new common stock, its underwriter indicated that the issue will have to be underpriced by $1 below the current share price. Further, the firm will have to pay $1 per share in issuance or floatation cost.

Additionaly, the firms marginal corporate tax rate is 40 percent.

(Given the information above)

A) find the firms before-tax cost of debt financing

B) find the firms after-tax cost of debt financing

C) find the firms cost of preffered stock financing

D) find the firms cost of financing using the retained earnings

e) find the firms cost of financing using a new common stock issue

f)find the firms weighted average cost of capital, if the firm uses debt, preffered stock and retained earnings to finance its investments. Given this result, explain what rate of return the firm should require from its investors.

g) Find the firms weighted average cost of capital, if the firm uses debt, preffered stock, retained earnings, and new stock issue to finance its investments. Given this results, explain what rate of return the firm should require from its investments.

Jordan Co.'s CFO is trying to determine the company's WACC. He has determined that the company's before-tax cost of debt is 8.7%. The company currently has $100,000 of debt, and the CFO believes that the book value of the company's debt is a good approximation for the market value of the company's debt. * The firm's cost of preferred stock is 9.9%, and the book value of preferred stock is $10,500. * Its cost of equity is 13.2%, and the company currently has $85,000 of common equity on its balance sheet. * The CFO has estimated that the firm's market value of preferred stock is $30,000, and the market value of its common equity is $140,000. Determine Jordan's WACC if its subject to tax rate of 40%.

Kuhn company is considering a new project that will require an initial investment of $20 million. It has a target capital structure of 35% debt, 2% preferred stock and 63% common equity. Kuhn has noncallable bonds outstanding that mature in 5 years with a face value of $1,000, an annual coupon rate of 10%, and a market price of $1,050.76. The yield on the company's current bonds is a good approximation of the yield on any new bonds that it issues. The company can sell shares of preferred stock that pay an annual dividened of $9 at a price of $95.70 per share. You can assume that Jordan does not incur any flotation costs when issuing debt and preferred stock.

Kuhn does not have any retained earnings available to finance this project, so the firm will have to issue new common stock to help fund it. Its common stock is currently selling for $22.35 per share, and it is expected to pay a dividend of $1.36 at the end of next year. Flotation costs will represent 8% of the funds raised by issuing new common stock. The company is projected to grow at a constant rate of 8.7%, and they face a tax rate of 40%. What is Kuhn's WACC for this project? Please show work.

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