Question

Company A has the following capital structure, which considers to be optimal:

Debt $50,000
Preferred Stock $20,000
Common Equity from retained earnings $15,000
Common Equity (new stocks) ?
Total Liabilities & Equity $100,000

The following information is relevant to Company A

• Before-tax cost of debt is 12%.
• The tax rate is 35%.
• Preferred stock with a dividend of $2 is currently sold to the public at a price of $30 per share.
• The common stock’s last dividend paid was $1 per share, and its common stock currently sells for $35 per share, and dividends are expected to grow at a constant rate of 8%.
• The company can obtain new capital by selling new common stock to the public with a flotation cost of 11%.

1) Company's A weight of debt is: *

a) 55%

b) 20%

c) 0.4

d) 50%

e) None of the above

2) Company's A weight of preferred shares is: *

a) $20

b) 20%

c) 25%

d) 0.4

e) None of the above

3) Company's A weight of common equity from retained earnings is: *

a) 30%

b) 15%

c) 20%

d) 5%

e) None of the above

4) Company's A weight of common equity from issuing new stocks is: *

a) 30%

b) 60%

c) 50%

d) 15%

e) None of the above

5) The after-tax cost of debt for Company A is: *

a) 4.2%

b) 7.8%

c) 12%

d) 35%

e) None of the above

6) Company's A cost of preferred stock is: *

a) $6.67

b) 14%

c) 6.67%

d) 10%

e) None of the above

7) Company's A cost of common equity from retained earnings is: *

a) 2.85%

b) 3.085%

c) 10.85%

d) 0%

e) None of the above

8) Company's A cost of common equity from issuing new stocks is: *

a) 3.21%

b) 3.46%

c) 11.21%

d) 11.47%

e) None of the above

9) Company's A weighted average cost of capital is: *

a) 8.54%

b) 7.41%

c) 10.91%

d) 6.89%

e) None of the above

10) Assume that company A has three projects X, Y and Z from which to choose: Project X Return: 10.85%, Project Y Return: 7.05%, and Project Z Return: 6.20% Based on your answer in question 9, which project (s) should the company choose? *

a) Projects X and Y.

b) Project X only.

c) Projects X, Y and Z.

d) Project Y only

e) Reject all projects

Answer 1