Question

The financial data for a corporation is provided to calculate all the following question. Most recent annual common dividend $4.00 Today’s common stock price $50.00 U.S. Treasury 10y annual rate 3 percent Market risk premium 5 percent Equity Risk Premium on Bond Yield 10 percent Number of common shares outstanding 2.5 million Today’s preferred stock price $100.00 Fixed preferred dividend $8.00 Constant growth rate 6 percent Beta β 2.0 Floatation costs for Preferred and common stock issuance 7 percent Market price of the bond $1,100.00 Annual coupon on the bond $70.00 Years to bond maturity 5 years Par value bond $1,000 Number of preferred shares outstanding 200,000 Number of bonds outstanding 200,000 Previous year annual Income Statement (amounts in millions) Sales $200,000 Variable operating costs (60% of sales) (120,000) Gross profit 80,000 Fixed operating costs (40,000) Net operating income (EBIT) 40,000 Interest expense (10,000) Taxable income 30,000 Taxes (12,000) Net income $18,000 Company can raise more debt by selling 50,000 new bonds at the same rate (interest) and receiving the market price of the bond i.e. $1,100. The outstanding 200,000 bonds and the additional 50,000 is the maximum the company can raise in debt. After this amount, the average after tax cost of debt will be increased by 1 percent. In the upcoming annual financial results, the company expects to generate 75 million dollars in retained earnings for the capital budgeting projects. Any requirement of funds beyond this would require issuance of new stock at the market price of $50 per share while maintaining the existing capital structure. Company has following projects for consideration Projects Investment Expected MIRR A $50 million 13 percent B $60 million 10 percent C $100 million 8 percent D $10 million 7.5 percent

Refer to the data set: What the average cost of company’s equity is with only retained earnings?

	a.	14.83 percent
	b.	14.06 percent
	c.	14 percent
	d.	42.19 percent

Answer 1

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