8. ABC\'s common stock currently sells for S32 per share. The firm\'s investment

Question

8. ABC's common stock currently sells for S32 per share. The firm's investment banker charges 6.5 percent flotation costs when new common stock is issued. The company expects to pay a S3.36 per share dividend at the end of the year. If the firm's cost of retained earnings is 15.5 percent, what is its cost of new common equity? 9. Billy Bob's capital structure consists of 20 percent debt, 30 percent preferred stock and 50 percent common stock. If the firm raises new capital, its after-tax cost of debt will be 3.5 percent, its cost of preferred stock will be 6 percent, its cost of retained earnings will be 10.2 percent, and its cost of new common equity wll be 12.4 percent. If Billy Bob's needs to raise S220,000 and it expects to generate S100,000 in retained earnings this year, what is its marginal cost of capital to raise the needed funds? 10. Sanders, Inc. is evaluating two independent investments. Project A costs S150,000 and has an IRR equal to 12 percent, and Project B costs $140,000 and has an IRR equal to 10 percent. Sanders capital structure consists of 20 percent debt and 80 percent common equity, and its component costs of capital are rd,-4%, r.-10%, and re-12.5%. If the firm expects to generate $230,000 in retained earnings this year, which project(s) should be purchased?

Explanation / Answer

Answer 8.

Current Price = $32.00 per share
Flotation Cost = 6.5%

Price after flotation = $32.00 * (1 - 0.065)
Price after flotation = $29.92

Cost of New Common Equity = Year-end Dividend / Price after flotation
Cost of New Common Equity = $3.36 / $29.92
Cost of New Common Equity = 0.1123
Cost of New Common Equity = 11.23%

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