Chen Chocolate Company’s EPS in 2016 was $1.25, and in 2011 it was$0.75. The company’s payout ratio is 50%, and the stock is currently valued at $37.75. Flotation costs for new equity will be 15%. Net income in 2017 is expected to be $18 million. The company’s investment banker estimates that it could sell 10-year semiannual bonds with a coupon rate of 5%. The face value would be$1,000 and the flotation costs for a bond issue would be 1%. The market-value weights of the firm’s debt and equity are 25% and 75%, respectively. The firm faces a 35% tax rate. - Calculate the firm’s cost of retained earnings and the cost of new common equity. - Calculate the break-point associated with retained earnings.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Chen Chocolate Company’s EPS in 2016 was $1.25, and in 2011 it was$0.75. The company’s payout ratio is 50%, and the stock is currently valued at $37.75. Flotation
The company’s investment banker estimates that it could sell 10-year semiannual bonds with a coupon rate of 5%. The face value would be$1,000 and the flotation costs for a bond issue would be 1%. The market-value weights of the firm’s debt and equity are 25% and 75%, respectively. The firm faces a 35% tax rate.
- Calculate the firm’s cost of
- Calculate the break-point associated with retained earnings.
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