The management of a conservative firm has adopted a policy of never letting debt exceed 30 percent of total financing. The firm will earn $10,000,000 but distribute 40 percent in dividends, so the firm will have $6,000,000 to add to retained earnings. Currently the price of the stock is $50; the company pays a $2 per share dividend, which is expected to grow annually at 10 percent. If the company sells new shares, the net to the company will be $48. Given this information, what is the
a. cost of retained earnings;
b. cost of new common stock?
The rate of interest on the firm’s long-term debt is 10 percent and the firm is in the 32 percent income tax bracket. If the firm issues more than $2,400,000, the interest rate will rise to 11 percent. Given this information, what is the
c. cost of debt;
d. cost of debt in excess of $2,400,000?
The firm raises funds in increments of $3,000,000 consisting of $900,000 in debt and $2,100,000 in equity. This strategy maintains the capital structure of 30 percent debt and 70 percent equity. Develop the marginal cost of capital schedule through $12,000,000. What impact would each of the following have on the marginal cost of capital schedule?
e. the firm’s income tax rate increases
f. the firm retains all of its earnings and the price of the stock is unaffected
g. $12,000,000 is insufficient to meet attractive investment opportunities