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Tutorial Cost of capital question

Course

Advanced Financial Management (BWFF2043)

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Students shared 127 documents in this course
Academic year: 2021/2022
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Tutorial Cost of capital (topic 4)

  1. Hijau Berhad preferred stock is selling for RM39 a share. The firm nets RM35 after issuance costs. The stock pays an annual dividend of RM3. per share. What is the cost of existing, and new, preferred stock respectively? What is the effect of floatation cost (issuance costs) to the overall cost of preferred stock?

  2. Merah Corp. is very risky, with a beta equal to 1 and a standard deviation of returns of 20%. The risk free rate of return is 2% and the market risk premium is 8%. Merah’s marginal tax rate is 35%. What is the market return? Use the capital asset pricing model to estimate Merah’s cost of retained earnings.

  3. Biru Corp. wants to issue bonds with a 9% coupon rate, a face value of $1,000, and 15 years to maturity. Biru estimates that the bonds will sell for $1,090 and that flotation costs will equal $15 per bond. Biru Corp. common stock currently sells for $30 per share. Biru can sell additional shares by incurring flotation costs of $3 per share. Biru paid a dividend yesterday of $4 per share and expects the dividend to grow at a constant rate of 5% per year. Biru also expects to have $12 million of retained earnings available for use in capital budgeting projects during the coming year. Biru’s capital structure is 40% debt and 60% common equity. Biru’s marginal tax rate is 30%. Calculate a. the after-tax cost of debt assuming Biru’s bonds are its only debt. b. the cost of retained earnings. c. the cost of new common stock. d. the weighted average cost of capital (WACC) assuming Biru’s total capital budget is $30 million..(hint: Biru use bond, internal and external source of fund)

  4. Pinky Bhd has determined its optimal capital structure which is composed of the following sources and target market value proportions.

Source of capital Target market proportion Long-term debt 600, Common stock 400,

DEBT: Pinky Bhd can sell a 10 year, RM1000 par, 8% bond for RM975. A flotation cost of 2% of the face value would be required in addition to the discount of RM10. The corporate tax rate is 28 percent.

COMMON STOCK : Pinky’s common stock is currently selling for RM24 per share. Last year dividend was RM1. Its dividend payments have been

growing at a constant rate of 8% per year. It is expected that to issue new common stock with the flotation cost of RM1 per share.

Based on the information given:

i. Calculate before- tax cost of debt.

ii. Calculate cost of common stock.

iii. Calculate the weighted average cost of capital for Pinky Bhd.

iv. Assuming there is a potential investment which has an expected return of 12%. Discuss your decision whether to invest or not.

  1. Discuss the effect of the floatation costs associated with a new security issue.

  2. Describe how is the investor’s required rate of return related to the firm’s cost of capital?

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Tutorial Cost of capital question

Course: Advanced Financial Management (BWFF2043)

127 Documents
Students shared 127 documents in this course

University: Universiti Utara Malaysia

Was this document helpful?
Tutorial Cost of capital (topic 4)
1. Hijau Berhad preferred stock is selling for RM39.00 a share. The firm nets
RM35.00 after issuance costs. The stock pays an annual dividend of RM3.50
per share. What is the cost of existing, and new, preferred stock respectively?
What is the effect of floatation cost (issuance costs) to the overall cost of
preferred stock?
2. Merah Corp. is very risky, with a beta equal to 1.8 and a standard deviation of
returns of 20%. The risk free rate of return is 2.5% and the market risk
premium is 8%. Merah’s marginal tax rate is 35%. What is the market
return? Use the capital asset pricing model to estimate Merah’s cost of
retained earnings.
3. Biru Corp. wants to issue bonds with a 9% coupon rate, a face value of
$1,000, and 15 years to maturity. Biru estimates that the bonds will sell for
$1,090 and that flotation costs will equal $15 per bond. Biru Corp. common
stock currently sells for $30 per share. Biru can sell additional shares by
incurring flotation costs of $3 per share. Biru paid a dividend yesterday of
$4.00 per share and expects the dividend to grow at a constant rate of 5%
per year. Biru also expects to have $12 million of retained earnings available
for use in capital budgeting projects during the coming year. Biru’s capital
structure is 40% debt and 60% common equity. Biru’s marginal tax rate is
30%. Calculate
a. the after-tax cost of debt assuming Biru’s bonds are its only debt.
b. the cost of retained earnings.
c. the cost of new common stock.
d. the weighted average cost of capital (WACC) assuming Biru’s total
capital budget is $30 million..(hint: Biru use bond, internal and external
source of fund)
4. Pinky Bhd has determined its optimal capital structure which is composed of
the following sources and target market value proportions.
Source of capital Target market proportion
Long-term debt 600,000
Common stock 400,000
DEBT: Pinky Bhd can sell a 10 year, RM1000 par, 8% bond for RM975. A
flotation cost of 2% of the face value would be required in addition to the
discount of RM10. The corporate tax rate is 28 percent.
COMMON STOCK: Pinky’s common stock is currently selling for RM24 per
share. Last year dividend was RM1.95. Its dividend payments have been

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