Define each of the following terms: a. Weighted average cost of capital, WACC; after-tax cost of debt, r d (1 – T); after-tax cost of short-term debt, r std (1 – T) b. Cost of preferred stock , r ps ; cost of common equity (or cost of common stock), r s c. Target capital structure d. Flotation cost, F; cost of new external common equity, r e

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Answer 1

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Students have asked these similar questions

Which of the following is generally excluded in estimating the weighted average cost of capital? c. Preferred Share d. Ordinary Equity a. Short-term debt b. Long-term debt

The weights used in calculating the weighted average cost of capital should be based on ________. a book values b estimated future values c market values

One should determine the after-tax weighted average cost of capital by Multiple Choice A) dividing the weighted average before-tax cost of debt to the weighted average cost of equity. B) adding the weighted average before-tax cost of debt to the weighted average cost of equity. C) adding the weighted average after-tax cost of debt to the weighted average cost of equity. D) multiplying the weighted average after-tax cost of debt by the weighted average cost of equity.

Answer 2

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 3

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 4

Textbook Question

Chapter 11, Problem 1Q

Define each of the following terms:

a. Weighted average cost of capital, WACC; after-tax cost of debt, r_d(1 – T); after-tax cost of short-term debt, r_std(1 – T)
b. Cost of preferred stock, r_ps; cost of common equity (or cost of common stock), r_s
c. Target capital structure
d. Flotation cost, F; cost of new external common equity, r_e

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

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Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 8

a)

Expert Solution

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 9

a)

Expert Solution

Answer 10

a)

Expert Solution

Answer 11

Expert Solution

Answer 12

Summary Introduction

To discuss: Weighted average cost of capital (WACC), after-tax cost of debt r_d (1-t) and after tax cost of short term debt r_std (1-t).

Answer 13

Explanation of Solution

Weighted average cost of capital is nothing but minimum (expected) required rate of return and it is also called as cut of rate. It includes cost of all sources like common stock, bonds in long term and preferred stock that are weighted proportionately while calculating weighted average cost of capital.

After tax cost of debt r_d (1-t), is the applicable cost to the company for new financing of debt. For this purpose, interest that accrues on debt is allowed as deduction for tax purposes.

If a company has short-term period debt with a cost of r_std, then it’s after tax cost is r_std (1-t), is the proper cost of debt.

Answer 14

b)

Expert Solution

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 15

b)

Expert Solution

Answer 16

b)

Expert Solution

Answer 17

Expert Solution

Answer 18

Summary Introduction

To discuss: Cost of preferred cost (r_ps) and cost of common equity (r_s).

Answer 19

Explanation of Solution

Cost of preferred stock is nothing but the cost of issuing new preferred stock by company. For perpetual preferred, it is nothing but preferred dividend divided by net issue price.

Cost of common equity is nothing but the cost of equity obtained by selling new common stocks of a company. It is basically, the cost of retained earnings income adjusted for floating costs. Floating costs are incurred when the company issues new securities for the first time.

Answer 20

c)

Expert Solution

Summary Introduction

To discuss: Target capital structure.

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 21

c)

Expert Solution

Answer 22

c)

Expert Solution

Answer 23

Expert Solution

Answer 24

Summary Introduction

To discuss: Target capital structure.

Answer 25

Explanation of Solution

The target capital structure is nothing but the relative amount of debt, common equity and preferred stock that an organization desires. Calculation of weighted average cost of capital is totally based on these target weights.

Answer 26

d)

Expert Solution

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 27

d)

Expert Solution

Answer 28

d)

Expert Solution

Answer 29

Expert Solution

Answer 30

Summary Introduction

To discuss: Flotation cost and cost of new external common equity.

Answer 31

Explanation of Solution

The concept of floatation cost is considered when a company issues a new security. This includes fees paid to investment bankers and other legal fees. The cost of new common equity is better than that of not unusual equity raised internally by reinvesting earnings. The projects financed with external equity must earn higher returns, since the projects must cover these flotation costs.

Answer 32

Ch. 11 - Define each of the following terms: Weighted...Ch. 11 - Prob. 2Q Ch. 11 - Prob. 3Q Ch. 11 - Distinguish between beta (i.e., market) risk,...Ch. 11 - Suppose a firm estimates its overall cost of...Ch. 11 - 11-1 After-Tax Cost of Debt Calculate the...Ch. 11 - Cost of Preferred Stock Duggins Veterinary...Ch. 11 - Prob. 4P Ch. 11 - Prob. 5P Ch. 11 - Prob. 6P

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