Chapter 10 Homework - Graduate Financial Management

Topics: Weighted average cost of capital, Stock, Stock market Pages: 4 (840 words) Published: April 30, 2012
1. Wtd Cost of Capital Global Technology’s capital structure is as follows:
Preferred Stock15
Common Equity50
The aftertax cost of debt is 6.5%; the cost of preferred stock is 10%; and the cost of common equity (in the form of retained earnings) is 13.5. Calculate Global Technology’s weighted average cost of capital.

| Prop| Cost| Weight| Composite|
Debt| 35%| 6.50%| 0.35| 2.275|
Preferred Stock | 15%| 10%| 0.15| 1.5|
Common Equity | 50%| 13.50%| 0.5| 6.75|
Totals| 100%| | 1| 10.525%|

2. As an alternative to the proportions above, an outside consultant for Global has suggested the following modifications:
Preferred Stock 5
Common Equity35
Under this new and more debt-oriented arrangement, the aftertax cost of debt is 8.8%; the cost of preferred stock is 11%; and the cost of common equity is 15.6%. Recalculate the firm’s weighted average cost of capital. Which plan is optimal in terms of minimizing the weighted average cost of capital?

| Prop| Cost| Weight| Composite|
Debt| 60%| 8.80%| 0.6| 5.28|
Preferred Stock | 5%| 11%| 0.05| 0.55|
Common Equity | 35%| 15.60%| 0.35| 5.46|
Totals| 100%| | 1| 11.29%|

Alternative plan raises cost of capital. The company should stick with the original financing plan to minimize costs.

Cost of Common Murray Motor Co wants you to calculate its cost of common stock. During the next 12 months, the co expects to pay dividends D1 of $2.50 and the current price of its common stock is $50 per share. The expected growth rate is 8%. a. Compute the cost of existing equity (use dividend approach) b. If a $3 floatation cost is involved, compute the cost of new common stock (Kn) (hint, use proceeds of new stock, net of floatation – issuance costs – in place of market price.
Ke = DPS...
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