A firm's target capital structure is 60 percent debt and 40 percent common equity.The firm's common stock
Question:
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?