Imbid-5728278nbNodeld 551651301746505011903490625N-9781 ,\'\'-MINDTAP Assignment

Question

Imbid-5728278nbNodeld 551651301746505011903490625N-9781 ,''-MINDTAP Assignment 10-The Cost of Capital The cost of issuing new common stock is calculated the same way as the cost of raising equity capital from retained O True: The cost of retained earnings and the cost of new common stock are calculated in the same manner except that the cost of retained earnings is based on the firm's existing common equity, while the cost of new common stock is based on the value of the firm's share price net of its flotation cost. False: Flotation costs need to be taken into account when calculating the cost of issuing new common stock but they do not need to be taken into account when raising capital from retained earnings. O White Lion Homebuilders is considering investing in a one-year project that requires an initial investment of $475,000 To do so, it will have issue new common stock and will incur a flotation cost of 2.00%. At the end of the year, the project is expected to produce a cash inflow of ss50,000. The rate of return that White Lion expects to earn on ts preject (net of its hiotation costs) is (rounded to two decimal places). 8.79% 9.46% A hasto se Transporters has a currents 12.17% $33.35 per share, andis expected to pay a per-share dividend of 52 03 at the end of next year. The com einstant rate at 5 20m rto the foreseeable future. If Alpha Moose expects to incur flotation costs of 3 750% of the and dividends growth rate are expected to grow at the e of ts ncely raised equity funds, then the flotation-adjusted (net) cost of its new common stock (rounded to two decimal places) shouid be White Uon tomebuilders Co,'s addition to earnings for this year is expected to be 857,000 Its target capital ,ur, consists of.35%, debt, 5% preferred, and 60% cquity Determine wnite Lon Homebuilders's retained

Explanation / Answer

Part A

Cost of issuing new common stock is calculated in the same way as cost of raising equity capital from retained earnings?

False : Floatation costs need to be taken into account when calculating the cost of issuing new common stock, but they do not need to be taken into account when raising capital from retained earnings.

Cost of issuing new common stock is different from cost of retained earnings, to put simply for retained earnings we donot need to raise capital as they are readily available with the company and its cost may be opportunity cost.

Part B

Initial investment required = $475,000

Flotation cost on issue of new stock = 2%

Cash inflow at the end of year = $ 550,000

Let X be the expected return net of flotation

Amount to be raised = 475,000/ 1-0.02

                                       = $484,694

Present value of cash inflow @ expected return on project for 1 year = amount raised

PVF ( X%, 1 year ) = 484,694/550,000

                                 = 0.881

PVF ( 13.52%, 1 year ) = 0.881

Therefore X , Expected return net of flotation cost is 13.52%

Part C :

Cost of newly issued stock with constant growth rate can be calculated as = [D1/P0 (1-F)]   + g

D1 =Dividend paid next year = $2.03

P0 = current stock price = $33.35

F = Flotation cost = 3.75%

g = constant growth rate = 5.2%

Cost of its new common stock = [2.03/33.35 (1-0.0375)] + 0.052

                                                       = 11.52%

Part D

Retained earnings breakeven point = Retained earnings / Fraction of equity

= $857,000/ 0.6

= $1,428,333

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