A firm's target capital structure is 60 percent debt and 40 percent common equity. The firm's common stock has just paid a dividend of $2 per share. It is expected that the dividends of this firm will grow at a rate of 10 percent per year in the future. The current price of the common shares is $30. If new common shares are issued, it will be necessary to incur flotation costs of $5 per share. The firm's bonds have a par value of $1,000; a coupon rate of 7 percent paid annually; 10 years to maturity; and currently sell for $1,050 each. Flotation costs on similar new bonds would be 4 percent of the par value on an after-tax basis. The firm is considering a project with an investment of $10 million. The firm doesn't have enough cash for the investment and will have to issue common shares to raise the $10 million. 

What is the required rate of return on this investment if the firm's tax rate is 40 percent and the project has the same level of risk as the firm?

Answer rating: 100% (QA)

Before computing the required rate of return we first need to determine the firms cost of equity and ... View the full answer