Question

1.) A firm needs to take flotation costs into account when it is raising capital from ___________ (retained earnings / issuing new common stock)

True or False: The following statement accurately describes how firms make decisions related to issuing new common stock.

2.) If a firm needs additional capital from equity sources once the retained earnings breakpoint is reached, it will have to raise the capital by issuing new common stock.

a.) False: Firms raise capital from retained earnings only when they cannot issue new common stock due to market conditions outside of their control.

b.) True: Firms will raise all the equity they can from retained earnings before issuing new common stock, because capital from retained earnings is cheaper than capital raised from issuing new common stock.

3.) Blue Hamster Manufacturing Inc. is considering a one-year project that requires an initial investment of $550,000; however, in raising this capital, Blue Hamster will incur an additional flotation cost of 6%. At the end of the year, the project is expected to produce a cash inflow of $715,000. The rate of return that Blue Hamster expects to earn on the project after its flotation costs are taken into account is __________ (18.11%, 19.24%, 15.85%, 22.64%)

4.) Blue Hamster has a current stock price of $22.35 and is expected to pay a dividend of $2.45 at the end of next year. The company’s growth rate is expected to remain constant at 4%. If the issue's flotation costs are expected to equal 6% of the funds raised, the flotation-cost-adjusted cost of the firm's new common stock is __________ (13.31%, 15.66%, 12.53%, 15.00%)

5.) Blue Hamster’s addition to earnings for this year is expected to be $857,000. Its target capital structure consists of 35% debt, 5% preferred stock, and 60% common stock. Blue Hamster Manufacturing Inc.’s retained earnings breakpoint is __________ ($1,499,750,   $1,785,416,   $1,356,916,   $1,428,333) (rounded to the nearest whole dollar).

Answer 1

1) Flotation costs are incurred by firm while raising money from outside means issuing new common stock as internal sources can not fulfill firms needs of funds

2) firm can raise more capital from any sourse but using proportion from retained earnings will be cheaper so TRUE.

3) D = 22.64

initial investment+ flotation cost= 550000+33000=583000

inflow from project= 715000

R= 22.64%

where R stands for return

4) d=15%

D= dividend P0= stock price F= flotation cost G= growth rate

=

= 15%

5) retained earnings break even is calculated as

=

so answer is D= 1428333