Question

Part A. A firm is planning to invest $750,000 in new projects and plans to borrow...

Part A. A firm is planning to invest $750,000 in new projects and plans to borrow 40% in bonds and issue shares for the remaining 60%. Flotation costs are expected to 6% for issuing shares for 2% for bonds. How much additional capital should they borrow to invest $750,000? Use the average flotation cost to determine the amount (as shown in the book).

a. $39,473.68

b. $34,518,.88

c. $65,217.39

d. $55,212.90

Part B. Book values, and not market values, of debt and equity should be used in estimating the cost of capital.

True

False

Business   Finance   
0 0
Add a commentTranscribed image text
Next >

Homework Answers

Answer #1

Part A. Answer is B. 34,518.88

We first need to calculate the weighted average cost of floating new issuances.

New weighted floatation cost = 40% * 2% + 60% * 6% = 0.8% + 3.6% = 4.4%

Capital to be raised such that company received $750,000 = Amount required/(1 - Floatation Cost) = 750000/(1 - 4.4%) = $784,518.83

Hence, extra capital required = $784,518.83 - $750,000 = $34,518.83

Part B. false

Book values record cost of the capital at the time of their issuance and hence do not represent the correct actual current position. Current psoition of the company as well as market risks do have huge influence on the market value of company's capital. In order to incorporate those risks and market considerations, market value needs top be used, to reflect the true cost of capital for company.

0 0
Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Log In

Sign Up

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
5.A firm has a target debt/equity ratio of 2 and is considering a new investment project....
5.A firm has a target debt/equity ratio of 2 and is considering a new investment project. The project would cost $1M to undertake but the firm has only $250,000 in retained earnings. The remaining $750,000 will be raised by selling bonds. The flotation costs of selling bonds are 5%. The flotation costs of issuing new equity are 12%. The firm has a policy of using only internal financing or debt (or both) for new projects. What is the weighted average...
The Cost of Capital: Cost of New Common Stock If a firm plans to issue new...
The Cost of Capital: Cost of New Common Stock If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected return is reduced so it may not meet...
Determining the Cost of Capital: Cost of New Common Stock If a firm plans to issue...
Determining the Cost of Capital: Cost of New Common Stock If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected return is reduced so it may not...
AHP2 Inc. expects its EBIT to be $12,500 perpetually. The firm can borrow at 5% but...
AHP2 Inc. expects its EBIT to be $12,500 perpetually. The firm can borrow at 5% but currently has no debt, and its cost of equity is 12%. It has 10,000 shares outstanding. The tax rate is 21%. AHP2 plans to borrow $40,000 and use the proceeds to repurchase shares. The additional borrowing is not going to affect the firm’s credit rating and accordingly the expected bankruptcy costs. AHP2 price per share will _______at the announcement of debt issuance and _________...
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an​ all-equity...
Your firm is planning to invest in an automated packaging plant. Harburtin Industries is an​ all-equity firm that specializes in this business. Suppose​ Harburtin's equity beta is 0.83​, the​ risk-free rate is 3%, and the market risk premium is 5% a. If your​ firm's project is​ all-equity financed, estimate its cost of capital. After computing the​ project's cost of capital you decided to look for other comparables to reduce estimation error in your cost of capital estimate. You find a...
Your firm is planning to invest in a new electrostatic power generation system. Electrostat Inc is...
Your firm is planning to invest in a new electrostatic power generation system. Electrostat Inc is a firm that specializes in business. Electrostat has a stock price of $25 per share with 16 million shares outstanding. Electrostat's equity beta is 1.18. It also has $220 million in debt outstanding with a debt beta of .08. If the risk-free rate is 3%, and the market risk premium is 6%, then your estimate of your cost of capital for electrostatic power generators...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected return is reduced so it may not meet the firm's hurdle rate for acceptance of the project....
1. the book value of a firm's capital accounts: a.should be used when evaluating new projects...
1. the book value of a firm's capital accounts: a.should be used when evaluating new projects b. flucutates frequently c, represents cost of existing capital d. a & c 2. The cost of new equity would increase with an increase in a. growth rate b. stock price c. flotation costs d. a & c e. all the above 3. If a firm had the following mix of capital components: Debt $25,000 Preferred stock $20,000 Common stock $55,000 its capital structure...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected rate of return is reduced so it may not meet the firm's hurdle rate for acceptance of...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be...
If a firm plans to issue new stock, flotation costs (investment bankers' fees) should not be ignored. There are two approaches to use to account for flotation costs. The first approach is to add the sum of flotation costs for the debt, preferred, and common stock and add them to the initial investment cost. Because the investment cost is increased, the project's expected rate of return is reduced so it may not meet the firm's hurdle rate for acceptance of...
ADVERTISEMENT
Need Online Homework Help?

Get Answers For Free
Most questions answered within 1 hours.

Ask a Question
ADVERTISEMENT