A firms target capital structure is 60 percent debt and 40 percent common equity. The firms common stock has just paid a dividend of $2 per share. It is expected that the dividends of this firm will grow at a

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?

• Expert Answer

1 The first step is to find the cost of the individual s View the full answer