I. Debreu Beverages has an optimal capital structure that is 50% common equity,
ID: 2799299 • Letter: I
Question
I. Debreu Beverages has an optimal capital structure that is 50% common equity, 40% debt, and 10% preferred stock. Debreu's pretax cost of equity is 12%. Its pretax cost of preferred equity is 7%, and its pretax cost of debt is also 7%. If the corporate tax rate is 35%, what is the weighted average cost of capital? A. between 7% and 8% B. between 8% and 9% C. between 9% and 10% D. between 10% and 12% 2. Using the constant growth model, a firm's expected (D dividend yield is 3% of the stock price, and its growth rate is 7%. If the tax rate is 35%, what is the firm's cost of equity? A. 10% B. 6.65% C. 8.95% D. More information is required 3. Expected cash dividends are $2.50, the dividend yield is 6%. flotation costs are 4% of price, and the growth rate is 3%. Compute cost of new common stock. A. 9.00% B. 9.25% C. 9.18% D. 9.44% 4, A firm's stock is selling for $85. The dividend yield is 5%. A 7% growth rate is expected for the common stock. The firm's tax rte is 32%. What is the firm's cost of retained earnings? A. 8.16% B. 12.00% C. 12.35% D. can not be determined. 5, Firm X has a tax rte of 30%. The price of its new preferred stock is S63 and its flotation cost is $3.15. The cost of new preferred stock is 12%. What is the firm's preferred dividend? A. $7.18 B. S5.03 C. $7.56 D. none of these.Explanation / Answer
1. option c. is correct
Tax rate will have effect only on debt capital.
2. Option A. is correct
Cost of equity= [Dividend /Market price] +growth rate
Dividend = market price*3%
Cost of equity= market price*3%/Market price +7% = 3%+7%= 10%
3. Option B is correct
Price of stock= dividend/dividend yield= 2.5/6%= 41.667
Cost of equity= [ D1/Price*(1-floatation cost)] +g
Cost of equity= [ 2.5/41.667*(1-0.04)] +3%= 9.25%
4. Option C is correct
Cost of retained earnings= D1/P +g
D1= dividend next year:
Current dividend= price * current dividend yield= 85*5%= 4.25
D1= dividend next year= dividend curret * (1+g)= 4.25*1.07= 4.5475
P= price of stock= 85
g= growth= 7%
Cost of retained earnings= 4.5475/85 +7%= 12.35%
5. Option A is correct
Dividend= (Price-flotation cost)*cost of preferred stock
Dividend= (63-3.15)*12%= 7.18
Capital After tax cost Weight Weighted cost a b c=a*b Equity 12% 50% 6.000% Preferred 7% 40% 2.800% Debt 0.0455 10% 0.455% WACC 9.255% a Debt cost 7% b Tax rate 35% c=a*(1-a) After tax cost of debt 4.55%