Question

1. A firm needs to take flotation costs into account when it is raising capital from __?___ .

2. True or False: Taking flotation costs into account will reduce the cost of new common stock.

True: Taking flotation costs into account will reduce the cost of new common stock, because you will multiply the cost of new common stock by 1 minus the flotation cost—similar to how the after-tax cost of debt is calculated.

False: Flotation costs are additional costs associated with raising new common stock.

3. Cute Camel Woodcraft Company is considering a one-year project that requires an initial investment of $500,000; however, in raising this capital, Cute Camel will incur an additional flotation cost of 6%. At the end of the year, the project is expected to produce a cash inflow of $600,000. The rate of return that Cute Camel expects to earn on the project after its flotation costs are taken into account is ___?____ .

4. Cute Camel 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 10%. If the issue's flotation costs are expected to equal 6% of the funds raised, the flotation-cost-adjusted cost of the firm's new common stock is ___?___ .

5. Cute Camel’s addition to earnings for this year is expected to be $745,000. Its target capital structure consists of 40% debt, 5% preferred stock, and 55% common stock. Cute Camel Woodcraft Company’s retained earnings breakpoint is ___?___ rounded to the nearest whole dollar).

Answer 1

Answer a)	A firm needs to take flotation costs into account when it is raising capital from __new common stock
Ans b)	Correct answer is : False: Flotation costs are additional costs associated with raising new common stock.
Answer c)
	intial investment			500000
	Flotation cost			6%
i	Total cost of investment =	500000*106%		530,000
ii	expected cash inflow =				600,000
iii=ii-i	return					70,000
iv=iii/i	rate of return					13.21%
	Ans =				13.21%
Answer d)	Current share price =			22.35
	Expected dividend =			2.45
	growth rate =				10.00%
	flotation cost =				6.00%
	We can use DDM model to find the cost of common equity
	Formula used =
	cost of equity =		Expected dividend/ (Price *(1-flotation cost)) + growth rate
			=(2.45/(22.35*(1-6%))+10%)
			21.66%
Answer e)
	retained earning breakpoint is the point where firm need not to go with issuing if new stock .
	Given that current equity ratio = 45%
	Additional earning =		745000
	At current capital structure firm need not to go for issue of new stock upto the investment of = 745000/55%
	earning breakpoint			1354545
	hence, correct answer is option :	1354545